Risky business: Why gov’t made sure Manila Water, Maynilad would earn

AT A GLANCE

READ: Part 1 | Public interest, private hands: How Manila Water, Maynilad got the deal


MANILA, Philippines 
– When water didn't flow from faucets in many parts of Metro Manila last March, President Rodrigo Duterte went on a rampage and threatened Manila Water and Maynilad he would scrap the concession agreements.

He went on to dig into the contracts’ contentious provisions on water rates – an issue that has lingered since water became privatized in 1997. 

He, however, failed to acknowledge the historical context of the deal, where economic conditions of the Philippines were very different then.

Most importantly, Duterte conveniently left out the fact that the past administrations failed to look for new water sources for the concessionaires to use. His proposed new water sources are a different issue altogether.

Duterte’s recent rants can be attributed to Manila Water and Maynilad’s wins against the government over an arbitration on water rates.

Rate rebasing

The concession agreement between the Metropolitan Waterworks and Sewerage System (MWSS) and the two concessionaires basically ensures that Manila Water and Maynilad will be able to recover what they spent to overhaul Metro Manila’s problematic water system.

According to the agreement, rates should be “set at a level that will permit the Concessionaire to recover over the 25-year term of the concession operating, capital maintenance and investment expenditures efficiently and prudently incurred, Philippine business taxes and payments corresponding to debt service on the MWSS loans and concessionaire loans incurred to finance such expenditures, and to earn a rate of return on these expenditures for the remaining term of the concession.”

The rates would change once every 5 years to take into account current market conditions, the Philippine economy’s performance, new laws, Metro Manila’s new needs, as well as the companies’ future investment plans.

A regular rate adjustment done yearly is also done. This takes into account inflation, foreign exchange rate, and even unforeseen events such as droughts.

The most controversial provision in the agreement was the inclusion of an applied discount rate (ADR), which basically grants Manila Water and Maynilad a guaranteed rate of return on their expenses. 

Computing for the ADR takes into account various figures, which include domestic and international interest rates, the country’s credit rating, currency risk, and cost of equity. 

Coming up with the escalation formula was very tricky, since MWSS had serious problems and it was hard for both the government and then-bidders to determine which projects to pursue or how much they would be spending.

This meant that computing for rates was quite a subjective process – an issue that officials back in the '90s acknowledged. During the deliberations, officials were even uncomfortable with how companies would earn from the deal. 

“First, it violated the principle of having an objective and uniform tariff escalation formula. Someone could bid with the idea of monkeying around later with the escalation procedure. Second, it was virtually a guarantee that the concessionaire would earn money. It removed the risk from the bid. Third, someone could bid low with the idea of recovering losses at the first rate rebasing period, five years hence,” said Mark Dumol, a former chief of staff at the Department of Public Works and Highways.

Dumol, who published his reflections regarding the deal in a World Bank report, said that officials were eventually convinced that the variables and process for the rate adjustment were the most logical at the time they crafted it. Moreover, he cited that the private sector would think twice in raising water rates since it is a highly-regulated commodity.

“[Unreasonably high returns] would be politically impossible. If the upside of their returns is limited, it is natural to expect that the downside should also be limited. Water is different. It is a monopoly. It is essential to life. It is highly political,” Dumol said.

Moreover, pressure to privatize was mounting when the concession agreement was being finalized. A former employee of MWSS who was eventually transitioned to one of the concessionaires told Rappler that officials were inclined to sweeten the deal, as public outcry grew stronger. 

“I remember that during the 90s, I did not want to pick up the phone or be associated with MWSS then, people would complain and get mad at me for the services. Morale was low and my bosses before who helped with the deal just wanted it to be done,” the employee said in Filipino.

MWSS Administrator Reynaldo Velasco echoed this sentiment back in March when Duterte slammed the contents of the agreement.

"They invested at a time when nobody wanted to invest in water utilities...From what we gathered, there is a concession because nobody wanted to do it before so there had to be an incentive so investors can come in," he said in Filipino.

In a nutshell, Manila Water and Maynilad took the risk of fixing water services without knowing just how bad the system was and whether their estimated costs for the overhaul would be enough. The government then came up with a deal that capitalists would find reasonable enough. 

While the quality of water services has significantly improved since water services were handed over to the private sector, progressive groups have long slammed how costs have gone up.

Arbitration

Tensions would rise every time rates are adjusted upward. A report from the Philippine Center for Investigative Journalism (PCIJ) back in 2013 said that MWSS and Manila Water clashed when the latter sent around 30 boxes of documents just before MWSS closed its doors.

“We’ve been asking for these documents in the past several months, and they kept delaying submission until now,” PCIJ quoted an irate staff at the MWSS Regulatory Office. “And then they send us a lot more boxes than expected.”

In 2013, the two concessionaires proposed to raise water rates. Maynilad wanted a hike of P8.58 per cubic meter or 25% higher to P42.55 per cubic meter. Meanwhile, Manila Water proposed a rate hike of P5.83 per cubic meter or 21% to P34.12 per cubic meter.

Instead of an increase, which the companies were entitled to get as per the concession agreement, rates were slashed by the MWSS in 2015.

MWSS argued that concessionaires cannot pass on income taxes to consumers.

Both companies took the case all the way to the Permanent Court of Arbitration in Singapore. Maynilad won their case in 2018, where the government was urged to pay the company P3.4 billion. Manila Water recently got a favorable ruling just last November, assuring the company of P7.4 billion from the Philippine government.

"Manila Water will work with the Republic for an orderly and managed satisfaction of the award," the company said.

Concessionaires can't rejoice just yet. Justice Secretary Menardo Guevarra said that while the companies won the arbitration, "it doesn’t mean it can be enforced at any given time because the Philippine government is ready to oppose any enforcement of that arbitral ruling."

Since Duterte's tirades, discussions on the government taking over water services sprang up once more. Can the government handle it?

"Unless and until the government is ready to efficiently run the distribution business, I guess for now we still have to rely on private concessionaires for the distribution of water supply," Guevarra said. (READ: PH government admits it's unable to take over water operations)

Modern times

The arbitration rulings seem to imply that both Manila Water and Maynilad have a strong legal footing over the issue of water rates. However, officials reviewing the rates and other provisions of the concession agreement must always go back to the historical roots of the agreement: that the government simply was not cut out for the job in the '90s and needed to attract the private sector.

That logic now has to be tested by modern 21st century conditions. 

In the '90s, the country's credit rating was far lower than what it is now and meant higher borrowing costs for companies. Logically, the government had to match prevailing interest rates with favorable clauses in the contracts.

In April of 2019, Standard and Poor upgraded the Philippines to BBB+ with a stable outlook, the highest ever in history. 

With lower interest rates, profits of both companies soared and they raked in billions and billions more each year.

Should the government clip their earnings anytime soon by renegotiating the concession agreement? It is both a legal and a business question, which is likely to be a precedent in succeeding public-private partnerships.

All about the cash

Maynilad and Manila Water's net income have significantly grown over the years.

Maynilad saw a 5% rise in core net income to P7.7 billion in 2018, while Manila Water grew by 6% to P6.5 billion.

Revenues of the companies average over P20 billion each year, indicating that they are heavy spenders as well.

Aside from projects, auditors must look even more closely at where the money is going.

MWSS previously questioned the companies for their philanthropic endeavors and practice of passing on the expenses to consumers. 

Moreover, the Manny Pangilinan-led Maynilad is seemingly spending a lot on sports. A document obtained by Rappler showed that Maynilad will be spending roughly P8 million to P10 million for sports-related activities for its highly-competitive workers-athletes. It will require some more digging by auditors, since financial statements sent over to regulators don't break down expenses to a granular level.

"Maynilad has a very competitive sports culture and we really want to win in all games when we compete with other MVP companies. Athletes are even excused for practice," a Maynilad insider who requested anonymity said.

Over at Manila Water, some departments have more managers than rank-and-file employees. Some don't have rank-and-file employees at all, indicating the high salary grade of employees.

Manila Water has grown tremendously over the years, it once dreamed of doubling its income by 2022 by aggressively expanding outside of the concession zone and diversifying its revenue stream. The company hoped to not rely so much on the concession area for income, as it approaches 100% coverage and scale nears a plateau.

Manila Water currently provides water to the property developments of Ayala Land, and has expanded to other areas like Boracay and even overseas. It also provides bottled water. The water business has synergized well with other Ayala companies.

While the concessionaires grew at a business standpoint and were even hailed by international award-giving bodies as among the best examples of privatization, questions on just how much they are allowed to earn has hounded them for years.

Manila Water currently slaps an average basic charge of over P25 per cubic meter. For Maynilad, it is over P35 per cubic meter.

Setting a cap on income simply does not fit in a capitalist structure. Government getting too touchy about private businesses is also a no-no in typical business arrangements.

With government admitting that it simply can't take over water anytime soon, and with the private sector proving its supremacy over delivering services, the challenge now is seeking a middle ground that will satisfy both regulation and business interests. – Rappler.com

Ralf Rivas

A sociologist by heart, a journalist by profession. Ralf is Rappler's business reporter, covering macroeconomy, government finance, companies, and agriculture.

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