Episode Transcript
[00:00:00] Speaker A: This is John Entspinger, General Manager of the Southern Nevada Water Authority in Las Vegas Valley Water District and you're listening to the Water Values Podcast. The Water Values Podcast is sponsored by the following market leading companies and organizations by 1898 and company possibilities Powered by Experience by Woodard and Curran High Quality Consulting Engineering Science and Operations Services by Entera Innovation and Stewardship for a Sustainable Tomorrow by Xylem Let's Solve Water by the American Waterworks Association Dedicated to the World's Most Important Resource by Black and Veatch Building a World of difference by 120 water new rules need New Tools by Suez Digital Solutions Optimizing Water IDE Water Technologies, your partner in water treatment and sustainable desalination for six decades and advanced drainage systems. Our Reason Is Water this is session 271.
[00:01:11] Speaker B: Welcome to the Water Values Podcast. This is the podcast dedicated to water utilities, resources, treatment, reuse and all things water. Now here's your host, Dave McGipsey.
[00:01:24] Speaker A: Hello and welcome to another session of the Water Values Podcast. As my daughter Sarah said, my name is Dave McGin and thank you so much for joining me and thank you as always for your support over the last 10 plus years. I hope everyone has had a phenomenal holiday and a safe and happy new Year. We're providing you today with the incredible opportunity to learn from Branko Terzik, Managing Director of Branko Terzik and Associates and a former Wisconsin PSC and FERC Commissioner. Branko has an incredible knowledge of history and utility regulations, so you're in for a real treat as he discusses why English calls for nationalization of England's water utilities are not well taken. And he also shares his ideas on the US System of water regulation.
[00:02:07] Speaker C: So this is right up my alley.
[00:02:11] Speaker A: I love this topic and Branko does a phenomenal job. And all in all, you're going to find Branko's discussion absolutely fascinating.
But before we get to that, a few announcements. First, as I announced in our last couple of episodes of 2024 for 2025, we're releasing just one episode per month and that will come out on the first Tuesday of every month. So this is the episode for January of 2025. Just want everyone to be aware of the new cadence of releases next. We always say thank you to our phenomenal sponsors at the top of every show and that will continue in 2025. Our sponsors from 2024 are all back with us and two new industry leading companies have joined our sponsorship family. So our 2025 sponsorship lineup includes 1898 & Co, Woodard & Curran, Entera Xylem, the American Waterworks Association, Black and Veatch, 120Water, Suez Digital Solutions, IDE Water Technologies, and Advanced Drainage Systems. And that is an absolutely terrific collection of impactful companies that have affirmatively decided to support water industry education and thought leadership. And I thank you all and I'd like for you to do me a favor.
[00:03:23] Speaker C: If you work for or with any.
[00:03:25] Speaker A: Of those sponsors, please thank your boss or thank your contact at the sponsor firm and let them know that you appreciate their leadership in the industry through that sponsorship. You'd be surprised how far that simple little note of thanks will go. Believe me, it goes a long way.
And hey, as long as you're letting sponsors know that you appreciate their support of water industry education and thought leadership, why not leave a rating interview on Apple Podcasts or whatever other podcast directory you're accessing the podcast on? It'd be greatly appreciated and of course helps others find out about the podcast. And don't forget to subscribe to the podcast. Yes, that'd be much appreciated.
Well, now it's time for our main event, the interview with Branko Terzik. So let's get that water flowing.
[00:04:08] Speaker C: Well, Bronco, welcome to the Water Values Podcast. It is great to have you on. How you doing today?
[00:04:13] Speaker D: I am doing fine, and I'm delighted that we're going to address this topic, which is one that I've dealt with for many years and I find quite interesting.
[00:04:21] Speaker C: Yeah, this is always a topic that I find very interesting, because there's one set of folks who want public ownership of utilities and one set of folks who want private ownership of utilities. And it's they don't cross paths very often. They don't intermingle much. So I'm really excited to talk about this topic of privatization and private ownership of utilities with you. But before we get into that, it would be very helpful, I think, for the listeners to provide a little bit of your background on who you are, how you came to the utility and water sector, and kind of what you're doing these days.
[00:05:03] Speaker D: Yeah, I'll be delighted. So I'm a graduate engineer and my first job out of school was with the American Appraisal Company, which at that time did valuations for rate base, and it also did depreciation studies and rate design for electric, gas and water utilities. After that, I was a consultant to water utilities in Wisconsin, doing their complete rate cases. The state of Wisconsin is unique in that IT has all 500 municipal water systems. And about 114 wastewater utilities are regulated by state law by the state Public Service Commission. And so during this period I was a consultant to about 15 cities, helping them with their small towns with their water rate cases and appearing before the Public Service Commission. By chance, at the age of 32, after doing that, I was nominated by Governor Lee Dreyfus of Wisconsin to be a commissioner on the Wisconsin Public Service Commission and ended up for six years regulating electric, gas, telephone and the municipal and the two privately owned water utilities which were then operating in Wisconsin. After leaving the commission after six years service, I was, I had water utility clients until I was appointed in 1990 to the federal Energy Regulatory Commission where I served as a commissioner from 90 to 93 and then after that was a utility executive with the gas utility and spent 15 years with Deloitte and Touche working with the auditors and accountants on public utility rate case, public utility rates and public utility issues. And so my, my water background goes almost five decades back.
[00:07:02] Speaker C: Yeah, I think you have the perfect background to discuss the issues about privately owned versus publicly owned water utilities. And I know you've recently written about the potential for water nationalization in England. So can you kind of tell us why did you choose that topic and give us a little background about what's going on? How did England have a fully privatized water system to begin with?
[00:07:28] Speaker D: Yes. So at the time Margaret Thatcher was elected the Prime Minister of England, all of the utilities were state owned. The electric, the gas, the water, the telephone were all state owned enterprises. They had been before World War II, private, in some cases private enterprises.
And then after World War II, there was a move to the left and a nationalization of much of the British industry, including British Rail and others. And so when she came into office, she believed that the state enterprises had become bloated, they had become inefficient. She was looking at what was happening in the United States with respect to the slow introduction of competition through PURPA and determined that they would try a different approach. They hired Professor Stephen Littlechild to do an analysis of what kind of regulation should happen if you privatized. And I met Little Child at that time. I was a state commissioner working with the State Commission and he contacted me and we talked about the options in regulating private utilities. And the option that was the only one really viable was what we call in this country the cost of service or rate of return type methodology, which was supported by the Supreme Court and also is the only system that works when you have private Capital involved. Little Child proposed to the British government a variant of that system which we call now incentive regulation, RPI minus X, where he said to avoid, to, to avoid annual rate increases, which you saw, we were rate proceedings that the utilities would have. Their base would start with the base rates that they had as government entities and then they would move ahead each year increasing or decreasing rates with the movement of the consumer price index there, what they call residential price, RPI minus a normal productivity factor. So the notion was if there was general inflation in the economy, each management ought to be introducing some productivity improvements that would beat the inflation. And so the formula was the rates would go up or down, RPI minus X this productivity factor. And for all of the, for the electric and gas and telephone companies, that was a negative number. So I think it was 2% for electric, 4% for telephone, meaning that each year automatically the phone industry, due to new technologies would be 4% more productive. With respect to the water utilities, it was known at that time that the state owned water utilities in the United Kingdom and England did not meet the new European Union water quality requirements, but that they had delayed and avoided capital investment in a new plant which was needed to meet the new water quality requirement. And so for the water utilities, they were set up under a formula of RPI plus X and the plus X, depending upon the estimate of how much new capital was needed for the company, could be as high as 30 to 50%. The upshot was after the privatization of those industries, and I have some charts which obviously you can't see, but the telephone rates went down by probably 60%. The gas rates went down by 50% up until 1997. The electric rates also dropped 30%, but the water rate doubled from the time of privatization till 1997. And so the public saw in the other utilities a improvement in productivity, a lowering of rates. But in the water sector they saw an increase of rates which would have occurred even if the water utilities had not been privatized. That new capital investment needed to be made and the capital cost of the water service would go up. So that was the sort of background. Now we've had problems in England and there are some discussions about going back to state ownership, which I think are not well advised.
[00:12:13] Speaker C: Yeah, so I think that's fascinating how the electric, gas and telephone utilities actually dropped in price once they were privatized, but water increased. And it seems to me that water utilities are unique in how they will continue to function and provide water, even if you're deferring maintenance. And I Think the ability to defer maintenance by publicly owned utilities is one of the reasons people have a misconception about the value of the price they should pay for water service.
[00:12:55] Speaker D: Yeah, that's exactly correct. One of the reasons that in this country the predominant ownership method of water is public is because the water utilities, number one, were a necessity, established in the early 1800s, late 1700s, going back to Roman times. But water was a necessity for life. It was a food product and it was a safety necessity with respect to fire protection. And so you had the necessity of water service, for example, in this country before you had capital markets, before you had large accumulations of private capital, before you had a New York Stock Exchange, you know, the first large capital, private capital enterprise in the United States was the railroad.
And they were also, of course, subsidized through some government efforts. So we had the water utility vitally essential, and people couldn't wait for private capital to be available. With respect to the other major utilities, electricity and natural gas, or gas service and telephone, those were all luxuries. And initially they weren't regulated because only the very wealthy could afford them. And they were luxuries that. Only that really the average person wouldn't see until later when they became necessities. Once the delivery of electricity became a necessity, the piped gas became a necessity, having a telephone became a necessity. Then the public decided that these had to be public service corporations, public utility corporations. They were vested with the public interest and the government had the right, according to the Supreme Court, to set the price, a fair price, for this privately provided service.
[00:14:52] Speaker C: Yeah, so that is fascinating. I know. I've talked to others about that. We haven't been able to figure out why the water sector is primarily dominated by publicly owned utilities versus the private sector. So that's a fantastic explanation. You mentioned earlier that there's a movement in England to nationalize and to reverse what Margaret Thatcher did in the 80s. So what's driving that? What kind of went wrong with English regulation?
[00:15:26] Speaker D: What went wrong was, to put it fundamentally, the public lost its confidence in the regulator. It lost its confidence in public regulation.
The regulator, I think, failed to the extent that no regulator here in the United States that I'm aware of would, would have allowed a regulated public utility to have a very debt heavy capital structure. We would have required them to go and get additional equity.
We would want to keep the composite cost of capital at the right level. Unfortunately, these companies were allowed to leverage greatly. And it was this leveraging which led to their problems. It led to the problem where they now still have capital investment to be made but nobody will loan them any money because they're over borrowed. And so there is a problem that in this country, under what we call ring fencing or affiliate interest standards, et cetera, any of the state regulators, we would have precluded any electric, gas, telephone or water utility to do what the British regulator allowed the British English water utilities do. And that is to leverage up highly and require minimum new capital from the investor.
[00:16:55] Speaker C: Interesting. So is that because of the RPI minus X and so they know they got a guaranteed return or is it because.
[00:17:02] Speaker D: No, no, once again, there's no guaranteed return.
It is rate of return regulation. All the RPI minus X does is it sets a price, but it doesn't guarantee a return, it just sets a price and then you operate the system at the end of the year, whatever your return is, it is. But you don't get to go in every year for a rate increase, even under RPI minus X, you have to wait the five or six year period. So it wasn't the RPI minus X, it was two things. One, the failure to regulate the capital structure, number one, and number two, to failure to insist that the water quality be as required by the European Union regulations. That is they were required to improve their systems. But apparently the regulators did not insist that those capital investments be made in a timely manner. And so we have complaints about water quality in the press report that my commentary was based on. The press report was a, in the New York Times on October 15th and the title of the article was Calls grow to Nationalize Water in England. And the calls were growing because the price was high, but the service quality was low. Once again, service quality is one of the things that regulators have to control besides the price, it's the capacity. So number one, utilities have to have adequate capacity, they have to have reliable and quality service and it has to be done at a reasonable price. So we had, we had a problem with English regulation that it did not follow that, that well known and standard regulatory practice.
[00:18:53] Speaker C: Yeah. So can you talk about capital structure and what they. So they were over, they had too much debt. What, what would you expect a typical American capital structure to be for a water utility?
[00:19:08] Speaker D: Yeah, it's historic. You know, I haven't looked very recently, but it's historically been at the around, you know, 50%, 50%, 40, 60 depending on the utility, depending on its need for capital.
Regulators will allow utilities to adjust.
If they're in a capital construction phase, they might allow one slight capital capital Structure versus another, but it's been generally balanced. Keep in mind, as you add more, you. I used to get the question when I was a state commissioner and the average citizen would say, well, this utility is 50% debt, 50% equity. The equity is at 12%, the debt is at 6%. Commissioner, why don't you just let them get all their money at 6%? Why are you making them get money at 12%? And you have to explain that the more debt you have, the debt rate goes up and your equity rate goes up. So if you add more debt, not only do you increase the price of the debt, but you increase the price of the equity because the equity holder is saying, holy cow, you've got this huge larger debt payment to make than you did before.
I'm concerned you're going to have enough cash left to pay me a dividend or to have profit for me. So as you increase your debt, both your debt and your equity rate go up. And the balance of course is. The regulator is looking for the lowest minimum composite cost of debt. Yes. And the investor is looking for the highest return on equity. But that's not what should be driving the regulator. The regulator is driven by the lowest composite cost of debt based on the circumstances of the company.
[00:20:54] Speaker C: Very well said. So I mean even publicly owned utilities, when they go to the markets, their bond covenants usually have like a 1.25 ratio for coverage.
[00:21:07] Speaker D: That's correct.
[00:21:08] Speaker C: And so it's kind of a. That's the analog to the private sector. Now you mentioned dividends earlier and you also mentioned ring fencing. So can you talk about those two concepts and how they apply in this situation?
[00:21:25] Speaker D: Yeah.
So the dividend. So once a utility makes the A for profit utility reports a net income, a profit it can. And after it's paid its interest charges, the management will determine what portion of that net income available to shareholders should be paid out in dividend and what portion should be reinvested in the business.
Many people prefer that they not receive a dividend cause that's taxable to them. They would rather that the. That the management reinvest in the enterprise. What has happened in the English case is apparently they paid excessive dividends and did not reinvest adequately in the enterprises. So that was a dividend. The ring fencing has to generally do with your affiliate transactions. Whether you're spending money with affiliates with the holding company.
What is that relationship like?
Is it appropriate?
Are the monies that are going between the parent company and the affiliate for services, for example, are they just and reasonable Costs frequently the parent company will provide maybe accounting and treasury services. It might provide legal services. Others it would charge the subsidiary utility for those, that's an affiliate transaction and you want those to be at the lower of, generally regulators like those to be at the lower of either cost or fair market value. And so that there is not an appropriate extraction of money from the regulated utility going to the parent company. And that's the ring fencing concept.
[00:23:12] Speaker C: Yep, yep. So in, in, in the case of England and the, the current calls for nationalization, how, how what, what are your thoughts on how the regulatory structure, regulatory scheme can be fixed to, to, to help out the private sector and make sure that they, they fix the issues about water quality and proper levels of equity?
[00:23:37] Speaker D: Well, well, clearly they'll need some regulatory orders ordering them to make, make certain investments. If they're not able to do so, the regulator, I don't know the specific laws in England, in this country, they could be ordered to divest and there are other, they could be ordered to pay penalties. There are other provisions. It'll be very specific to what the British law allows. And so I'll just leave that open.
They could order them to sell to a traditional utility provider with more experience, for example, than a financial holding company.
They might order mergers. If they have a weak system next to a, a healthy system, maybe a merger might be another. So there are various tools, various tools available once again depending upon the authority of the regulator, regulatory structure that you've got in the country.
[00:24:41] Speaker C: So Branko, can you discuss how that English model might translate to the US model and maybe give us a little history of how privatization has attempted to take root in the U.S.
yes, we.
[00:24:58] Speaker D: Had a period in the, I want to say, 90s where there was spurred by Enron. If you remember Enron, I had a call from Energy Daily to come to their annual conference. I had a call from the publisher at that time and he said come to the conference, be quiet. Was Ken Lay of Enron is going to make a spectacular new announcement. And so I was then, I think, CEO of Yankee Energy up in Connecticut. So I came down to Washington and went to the conference and sat in the front row and listened to Ken Lay explain how Enron was going into the water utility business.
And he laid out a series of steps that he said that I forget the name of the entity that his company was going to. They had just purchased one of the British water utilities and they were going to bring over the British water practices of RPI minus X to this country.
And they were going to emulate the French system of concession. Now, in the United States, the water utilities are predominantly owned by the cities municipalities. That is also true in France, except after World War II, the municipalities decided that they would not operate the systems. They would have competing firms compete for what are called concessions, where you bid to operate the system for a certain number of years, 10 or 20 years, and during that period you extract savings, you're more efficient and you share those savings with the municipality. You can share them on an ongoing basis, or in some cases there was an upfront cash payment by the concessionaire to the city for the right to operate the utility. In this country, a couple of utilities which got into financial and operating problems. And I'm thinking of in Atlanta and in Milwaukee Metropolitan Sewer District. They went ahead and the city government decided to do the concession model.
And they did. They did turn over their systems to concessionaire. I forget which one of the two. All of the French firms, of course, immediately came to America when they saw that was a possibility. And there was a lot of discussions in marketing among many of the water listeners, probably on this call, who will have had calls from concessionaires asking whether their municipalities would be interested in a concession. What was particularly attractive was the fact that they had this model where they would, let's assume they thought over a 20 year period they could save 100 million over the rates that were operation of the municipal system.
And they would then take part of that up front and give it to the city. So the city councilmen and city mayors had this carrot dangled in front of them that they would get X millions right up front for signing the concession. And then later the concessionaire would, based on operating rates, would recover that and more.
And so that was the model out there.
It quickly degenerated into a bidding contest where the cities got smart really fast and said, well, if you're offering us 100 million upfront or 50 million up front, you're probably going to make 100, so why don't you offer us 75 or 80 or something more than you're offering. And at that point the demands for the concession got out of economic realm and that pretty much stopped and dried and dried up. And so there was this kind of semi privatization talk where the assets would not be sold and the concession may or may not push the rate making to the state regulator generally, not because most of the statutes have to do with ownership of water assets, not the operating license. And so the cities would avoid the state regulation, but then they would have the private operator and Ken Lay with his company was going to get into that business. What astounded me was he gave five or six bullet points of what he was going to do and everything that he proposed to do would have been illegal or impossible under the kind of regulation that I was aware of. And in fact, I think they burned through I don't know how many billions of dollars in that water operation that Enron had.
[00:30:24] Speaker C: That's fascinating history. So right now in the US there's, give or take, about 85% of the water systems are publicly owned.
So do you have any impressions about what? Because there's a lot of talk about privatization, about companies, private, private sector coming in and essentially taking care of all the deferred maintenance that have happened in some of these publicly owned systems, which will naturally cause rates to increase.
So is, do you have any impressions about how the US could go the route of England and increase privatization levels, maybe not fully privatized, but to increase its share of the private sector and providing water service?
[00:31:16] Speaker D: Yeah.
My opinion is that any problems in the U.S. water utility industry are not the result of operations by municipal operators. They're perfectly adequate. They do a fine job. The problem is not with the operation, it's with the structure of the industry. If you've got 55,000 water systems, which I think is the number that the EPA puts out there, and 3,000 reasonable size ones right now, there isn't a municipal mechanism to consolidate systems regionally to gain advantages of scale and scope, to have centralized treatment, to take care of diversity of supply. If you've got many, many small municipalities out there struggling, that's the problem.
It is the structure of city borders and the limitation that a city would have of, for example, acquiring or operating its suburban or rural systems, that is the barrier, I think, to more efficient operation and to solve the problem that many smaller communities have.
And so in that instance, the only solution may be some privateers and indeed some state commissions are now allowing private utility owners to buy these ultra small water systems and to base rates not on the original cost of the system, which is the traditional regulatory method, but to allow them to base their rates on the new fair value basis on what they paid for the system and order as an inducement to get these systems purchased to get them up and operating. So as you know, after the establishment of the Environmental Protection Agency, there were many systems in the country that did not have adequate water treatment. And so the EPA would give grants conditional on the water treatment plant being sized economically to treat an area, not just to be sized to treat one municipal utility. And we have that in the northern Milwaukee area. We've got a treatment plant that's serving multiple municipal systems. And that was one of the solutions to the problem where they couldn't consolidate the systems. But the EPA said, well, you can have joint ownership, ownership of the treatment plant. So that's, I think the system that's out there. Occasionally there will be a system which will run into problems and the city managers or the political authorities will decide, you know, let's put it out for privatization, understanding that a privatized water utility will be strictly regulated by the state Public Service Commission and rates would be reviewed just and reasonable, etc.
[00:34:48] Speaker C: Absolutely. Well, Bronco, this has been a fascinating discussion. I have learned a lot. I really appreciate you taking the time to sit down with me. For those who want to find out more about you and your work, where can they go to get that information?
[00:35:02] Speaker D: They can go to www. Broncoterazik.com that's B R A N K O T E r z I c.com and thank you very much, David.
[00:35:14] Speaker C: Yes, it's been terrific. Thanks so much, Branko, and we'll be back in touch soon. Thank you.
[00:35:19] Speaker D: I look forward to it. Thank you. Bye bye bye.
[00:35:23] Speaker A: What a font of knowledge. Thanks, Bronco, for reaching out and sharing some of your vast knowledge of utility regulation and history. And it was just a phenomenal interview and being able to sit at your feet and learn was an incredible opportunity. So thanks for sharing your knowledge with us.
[00:35:40] Speaker C: Greatly appreciate it.
[00:35:41] Speaker A: Well, I'd love to know what you thought about the interview. Please check out the Show Notes page for information and links on this episode. Just Google the Water Values Podcast. Click the first link that comes up. That's our home on the web.
For those longtime listeners. You know that Bluefield Research and the Water Values LLC are not affiliates. We just have a joint marketing arrangement. And as part of that joint marketing arrangement, Bluefield Research gives the Water Values a home on the web.
Well, you can email me at david.mcgimpseydentons.com and you can sign up for the newsletter at that landing page I mentioned earlier as well. Thank you again for tuning in and I hope you make it a great day. Plus, I want to give a huge thank you to our sponsors again. Sponsors of the Water values podcast include 1898 and Company, Woodard and Curran, Entera Xylem, the American Waterworks Association, Black & Veatch, 120 Water, Suez Digital Solutions, IDE Water Technologies and Advanced Drainage Systems. And this show would not be possible without those great companies and industry leaders.
[00:36:44] Speaker C: And again, thank you for listening and.
[00:36:46] Speaker A: For subscribing to the Water Values Podcast. Your support is truly appreciated as stated at the top of the show. Happy Holidays to all of you and hope you've had a fantastic new Year and we'll see you again on the first Tuesday in February. In closing, please remember to keep the core message of the Water Values Podcast in mind as you go about your daily business. Water is our most valuable resource, so please join me by going out into the world and acting like it's.
[00:37:43] Speaker D: You'Ve.
[00:37:44] Speaker B: Been listening to the Water Values Podcast. Thank you for spending some of your day with my dad and me.
[00:37:49] Speaker A: Well, thank you for tuning in to the disclaimer. I'm a lawyer licensed in Indiana and Colorado and nothing in this podcast should be taken as providing legal advice or as establishing an attorney client relationship with you or with anyone else. Additionally, nothing in this podcast should be considered a solicitation for professional employment. I'm just a lawyer that finds water issues interesting and that believes greater public education is needed about water issues. And that includes enhancing my own education about water issues because no one knows everything about water.
