Implications of the Market and Regulatory Environment in China
on Multinational Water Companies
by
Wen Zheng, Lung
Bachelor of Engineering, Bioengineering (Honors)
Nanyang Technological University, 2009
SUBMITTED TO THE MIT SLOAN SCHOOL OF MANAGEMENT
IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE
DEGREE OF
MASTER OF SCIENCE IN MANAGEMENT STUDIES
AT THE
MASSACHUSEITO w1rWEM
MASSACHUSETTS INSTITUTE OF TECHNOLOGY
JUN 18 2014
OF TECHNOLOGY
JUNE 2014
LIBRARIES
©2014 Wen Zheng, Lung. All Rights Reserved.
The author hereby grants to MIT permission to reproduce and to
distribute publicly paper and electronic copies of this thesis document in
whole or in part in any medium now known or hereafter created.
Signature redacted
Signature of Author:
IT Sloe School of Management
May 9, 2014
Signature redacted
Certified By:
Matthew Amengual
Assistant Professor, Institute for Work and Employment Research
Thesis Supervisor
Accepted By:
Signature redacted
l/
Michael A. Cusumano
SMR Distinguished Professor of Management
Program Director, M.S. in Management Studies Program
MIT Sloan School of Management
[Page intentionally left blank]
Implications of the Market and Regulatory Environment in China
on Multinational Water Companies
by
Wen Zheng, Lung
Submitted to the MIT Sloan School of Management on May 9, 2014
in partial fulfillment of the requirements for the degree of
Master of Science in Management Studies
ABSTRACT
Amidst China's rapid industrialization and urbanization following market-oriented reforms in its
economy, the shortcomings of the state-controlled municipal water sector was brought to the fore.
The Chinese government realized the critical role water played in fuelling China's continued
economic growth, and implemented a series of water policy reforms in the 1990s which opened up
Chinese municipal water services to multinational water companies. In this paper, we track the
development of the Chinese municipal water sector to understand how regulatory changes and the
market environment has affected the way foreign multinational water companies operate in China.
In particular, we analyze the activities of Veolia Water and Suez Environnement, seeing how the
liberalized regulations governing public-private partnerships, along with water tariff reforms,
presented large growth opportunities for both companies. We also see how the same liberalizations
intensified competition for projects, necessitating a shift in strategic focus of the foreign
multinational water companies. Finally, the paper offers recommendations on how foreign
multinational companies can sustain growth opportunities aligned with the development of highly
regulated markets.
Thesis Supervisor:
Title:
Matthew Amengual
Assistant Professor, Institute for Work and Employment Research
[Pageintentionally left blank]
TABLE OF CONTENTS
Abstract
Table of Contents
List of Tables
List of Figures
Introduction ............................................................................................................................................................7
M ethodology ....................................................................................................................................................................................7
Lim itations..................................................................................................................................................................................... 10
Background ........................................................................................................................................................... 11
A thirsty country in the midst of rapidindustrializationand urbanization................................................... 11
The w atersupply-dem andgap............................................................................................................................................. 12
Urban w aterm arket structure............................................................................................................................................. 14
PPPin the Chinese W aterSector......................................................................................................................................... 16
The sensitivity of w aterprovision....................................................................................................................................... 21
Legislationon w ater.................................................................................................................................................................22
D evelopm ent of W ater Policy in China ....................................................................................................... 23
PrivatePublic Partnershipsin China'surban water services................................................................................ 24
W aterTariff Reform ..................................................................................................................................................................27
V eolia & Suez in China .......................................................................................................................................30
Veolia Water.................................................................................................................................................................................30
Suez Environnement .................................................................................................................................................................34
PPPA ctivity Data........................................................................................................................................................................38
Further Discussion .............................................................................................................................................43
Scale of Operations....................................................................................................................................................................43
Contracttype ...................... I ......................................................................................................................................................... 44
Sector - Water&Wastewater............................................................................................................................................... 45
Dom estic Competition ..............................................................................................................................................................46
ProspectsforM N Cs.................................................................................................................................................................... 48
Conclusion ............................................................................................................................................................. 50
Appendix A: Water-related agencies in the Chinese government .................................................... 52
Appendix B: Veolia's PPP contracts in China.......................................................................................
53
Appendix C: Suez Environnement's PPP contracts in China ...............................................................
55
References.............................................................................................................................................................
58
LIST OF TABLES
Table 1: Major brownfield project portfolio acquisitions in the Chinese water sector in 2013 .......... 21
Table 2: Breakdown of total population served by Veolia & Suez under each contract type...........40
LIST OF FIGURES
Figure 1: Water demand in China. (left) Water demand by sector, 2005 - 2030. (right) Uneven
distribution of water stressed provinces in China.........................................................................
12
Figure 2: Municipal water market structure, highlighting the opportunities for private sector
participation (in blue)......................................................................................................................................14
Figure 3: The spectrum of private public partnership arrangements in infrastructure projects........16
Figure 4: Global private sector activity in water infrastructure. .................................................................
26
Figure 5: Laws and regulations relating to PPP water projects in China .................................................
27
Figure 6: Veolia Water global revenue breakdown by geography..............................................................30
Figure 7: Veolia Water's bids for large concession contracts in Tianjin and Lanzhou.......................32
Figure 8: Shanghai Pudong Veolia Concession Model.......................................................................................33
Figure 9: Suez Environnement global revenue breakdown by geography and sector. .....................
34
Figure 10: Shareholding structure of Suez Environnement and New World Development in SinoFren ch W ater.......................................................................................................................................................3
5
Figure 11: Tanzhou Water Supply Company concession model...................................................................37
Figure 12: New populations served by Veolia & Suez in China in the last two decades....................39
Figure 13: Average population served by new contracts won by Veolia & Suez in China in the last
tw o decad es..........................................................................................................................................................4
0
Figure 14: Veolia's & Suez's new contracts in China - breakdown by contract type............................41
Figure 15: New PPP contracts in China's urban water sector - breakdown by sector.......................42
Figure 16: New PPP contracts in China's urban water sector - breakdown by project sponsor..........42
Introduction
Amidst China's rapid industrialization and urbanization, the Chinese Central Government
implemented a series of water policy reforms in the 1990s, revising water tariffs and transferring the
responsibility of providing urban water supply and sewage treatment from the central government
to municipal governments. Private investment was also allowed into the Chinese water industry for
the first time, opening the way for multinational water companies such as Veolia Water and Suez
Environnement to invest in China through public-private partnerships (PPPs).
Foreign water companies that developed water infrastructure in China earned handsome profits
thanks to the guaranteed investment returns defined within the PPP contracts that they entered. But
in 2002, the Chinese government annulled the scheme of guaranteed returns for foreign capital in all
business sectors, including water, which led a number of multinational water companies to sell their
shares in Chinese water assets back to municipal governments.
Despite the large inflow of foreign capital, multinational water companies still account for a small
percentage of the entire water market today. The Chinese water industry is now dominated by local
water companies that compete aggressively for projects at prices that are difficult for the
multinationals to maintain. The local water companies enjoy stronger governmental support and
have access to a lower cost of capital than their multinational counterparts, as many are statecontrolled enterprises.
These, among other factors, result in an increasingly challenging environment for Veolia and Suez, a
vastly different landscape from the 'land of opportunity' foreign companies expected to enter two
decades earlier. It also depicts a situation that is familiar to other multinational companies that are
active in China, who have to adapt in tandem with the country's rapidly changing market, increased
competition, and shifting government priorities. 1,2
This paper analyzes the changing landscape of China's municipal water market with respect to
regulatory changes and intensified competition in the last two decades from the perspective of Veolia
and Suez, to set the stage for understanding the opportunities for their future growth in China. There
exist academic papers on public-private partnership (PPP) structures in China, that highlight the
advantages, disadvantages, and challenges faced by the various PPP stakeholders using specific
projects as case studies to illustrate their theses. However, the parameters for each PPP project can
be extremely specific and lack wider applicability outside of the particular project characteristics
discussed in each study. This is especially true of some of the earlier projects in China that are
regarded by the Chinese government as pilot projects in their policy experiments. In this discussion,
we mitigate the subjectivity of such specific studies by focusing on the project activity data of two
multinational water companies over a period of time, instead of one or a few specific projects.
Methodology
To understand how regulatory changes and the market environment has affected the way foreign
multinational water companies operate in China, we begin by tracking the development of the
Chinese municipal water sector and policies surrounding PPP. Research is conducted by studying
academic papers covering China's environmental and water policy, water tariffs, water infrastructure
development, infrastructure privatization, and case studies of multinational corporations involved in
water management in China.
7
We then analyze the activities of Veolia Water and Suez Environnement in China, especially their
activities after 1994, when the Chinese government officially began encouraging PPPs as a means for
developing infrastructure, and collect data on the contract gains of the two companies until 2012.
The activities of both companies are measured in terms of the scale of operations, and the type of
PPP arrangement defined under each contract (referred to as "contract type" hereafter). These
parameters are then analyzed against the backdrop of policy changes to identify causal effects that
explain noticeable shifts in the activities of each company, and examine how each company
capitalized on the opportunities that the liberalized regulations governing public-private
partnerships, as well as water tariff reforms, presented to them. Policy changes can affect the
companies
Water tariff increases Contract data is compiled from numerous sources, including: the companies'
annual reports, websites, and news releases, academic papers, Global Water Intelligence, China
Water Risk, Pinsent Masons Water Yearbook 2012-2013, as well as data released by Chinese
government ministries and official news reports.
PPP project data from the World Bank's Private Participation in Infrastructure (PPI) database is also
used as a basis for comparison with the contract data of Veolia and Suez, to give us greater contextual
information on the overall level of activity in the water PPP sector during the period of our analysis.
Subsequently, we also examine the rise of domestic water companies and again analyze the contract
gains of Veolia and Suez over time, against the backdrop of the domestic water companies'
development The paper concludes by offering recommendations on where Veolia and Suez can find
sustained growth opportunities aligned with the development of China's municipal water sector.
Why compare Veolia Water and Suez Environnement?
Veolia Environnement and Suez Environnement are selected for this analysis because of their
comparability and the length of time that they have been operating in China. Veolia and Suez are the
two largest environmental services MNCs globally, and they compete head to head in almost every
region around the world, more than any other two water companies. Both companies had a similar
value proposition to Chinese municipalities; leading edge water treatment technology, over a century
of global water operations experience and management expertise, as well as strong balance sheets
with which to finance new projects in China.
In addition, both Veolia and Suez have a relatively long and undisrupted period of activity in China,
and have on numerous occasions expressed their plans to further expand their operations in China.
This will allow for a more meaningful comparison, compared with many other MNCs, some of which
are decreasing their exposure, or have already exited the Chinese water market altogether when
guaranteed investment returns were made illegal in 2002.
However, both companies also adopted different strategies in entering what was widely regarded as
a lucrative water sector in China. Veolia targeted large municipal contracts in the wealthiest and
largest cities in China, while Suez also aimed at high-income areas, but with smaller contract sizes.
The difference in their approaches towards the scale of operations of each project and the types of
contracts entered represents two different levels of risk acceptance, and allows us to examine how
the two strategies adopted by companies competing in the Chinese municipal water sector fared,
while mitigating the limiting effects of organizational resources and technological capabilities in their
strategic choices, as both companies are relatively evenly matched in these areas. It is therefore
interesting, and useful to follow the developments of Veolia and Suez in China to see how their
8
respective strategic choices have been affected by the regulatory and market environment in China,
as we will do in the following discussion.
Use of "scale of operations" and "contract type" as dependent variables
The municipal water infrastructure constructed and operated by Veolia and Suez represent sizeable
capital investments. Given that the water industry in China is a highly regulated business in a weak
institutional environment, 3 these infrastructure assets are vulnerable to obsolescing bargains, and
neither company can reliably depend on contractual agreements with the Chinese government to
protect their investments. It is therefore pertinent that as Veolia and Suez seek to build their Chinese
water portfolio that both companies balance the tension between seeking to grow their revenues and
maximize profits in China, and managing the degree of risk of their investments.
As alluded to earlier, Veolia and Suez are the only two global water service providers; both companies
have substantial financial resources, and have similar technological capabilities and water
infrastructure management know-how. Neither company has a strong competitive advantage over
the other in China. It is also useful to remember that the price of water is set by the government and
not by Veolia or Suez. The operations of Veolia and Suez in China differ in a number of aspects, but
the most obvious levers of how their strategies materialize in China is through the cumulative control
they have over revenue-generating water infrastructure assets (scale of operations), as well as the
type of contracts that they engage in. We elaborate on the scale of operations in the following text,
and further discuss the different types of contracts and their associated risks in the "Types of PublicPrivate Partnership (PPP) arrangements" section.
Use of "population served" to measure scale of operations
The metric that is used to track the scale of operations of each company in this analysis is the size of
the population that is served by the water infrastructure under the control of each MNC. "Population
served" is used because it is a more objective measure of the actual scale of operations for each
contract. The number of people living within a defined urban area in a Chinese city can be determined
to a relatively good accuracy given China's 'hukou' system, which provides accurate demographic
data on the residential status and movement of all the people within any particular city. The size of
the population served by a particular PPP contract is therefore easily verifiable.
The dollar amount of the initial investment put in by the MNC is a possible alternative to this metric,
as it approximates the value of the assets within the PPP arrangement. However, it may not
accurately reflect the actual size of the water services provided, as it is complicated by the maximum
shareholding that the MNC is allowed to own, as well as a measure of potential returns and risk that
cannot be easily verified given the long term nature of the contracts. For example, the premiums
Veolia Water pays for winning tender bids for contracts is based on its expectation that water
services within its concession area will grow. This reflects a projection made many years into the
future, given that contract lengths could extend up to 50 years, a projection that may not eventually
come to pass and is therefore a subjective measure.
The sum of water treatment capacities of each company's water infrastructure assets is another
possible measure that can be used to compare both companies' scale of operations, and this would
be a suitable metric given that the revenue from BOT and TOT contracts are usually determined
based on the volume of water sold to the municipal authority. However, treatment facilities are rarely
run at full capacity as there always needs to be a buffer capacity so that the facility is able to cope
with sudden spikes in treatment capacity, especially in the case of wastewater treatment facilities,
9
and buffer capacity requirements differ according to water demand variations that are specific to
each city. Also, treatment capacity may provide a skewed view of concession operations, especially
in cases where non-revenue water levels are high, and in China, the average non-revenue water
averages to around a 20 percent loss in water that is sent into the distribution network. The
treatment facility utilization, buffer capacity requirements, and non-revenue water levels all vary
between cities with different levels of development, 4 and it would therefore be subjective to measure
each company's scale of operations by their respective treatment capacities.
Limitations
While China's water policy applies at a national level, its implementation varies widely between
different municipalities, as China is not one homogenous market - there are enormous differences in
affluence, water tariffs and water resource quality between sub-regions in each province of China.
Also, comprehensive information on the project bids submitted for government tenders for water
plants in China cannot be easily obtained, which makes direct comparison of the competitive
behavior for individual projects between water companies in China challenging. At the same time,
the Chinese central government's experimental approach to developing national policy also means
that certain individual projects are exceptions and cannot be taken to represent other projects.
Therefore, we are more concerned with trend analysis and do not seek to harmonize the observations
in every single project.
Also, the study will focus primarily on municipal PPP water projects, which are governed by long
term contracts typically lasting more than 20 years. The length of such contracts represent significant
risks to the multinational water company, and decisions have to be highly consistent with each
company's strategy. Engineering, procurement, and construction (EPC) contracts and equipment
sales follow very different timeframes as they are usually completed within 3 years. They abide by
different business models and are therefore left outside the boundaries of our discussion.
It must be noted that the dataset includes information on contracts of all statuses, even ones that may
have since been terminated. Terminated projects are included in this study because they provide
valuable information on the kinds of contracts that our companies of interest sought to enter in the
situational context at each point in time. However, unsuccessful bids for contracts are not included
for two reasons. First, not much information on unsuccessful bids is made publically available, and
an incomplete record will not facilitate a meaningful comparison. Second, when municipalities put a
project up for tender, they usually preselect companies to participate in the bids. The invited
company may not necessarily find that the project fits into their strategic plan, and instead of
declining the municipal governments, it is common for such a company to submit an unattractive bid
and be dropped from the preferred bidders list. The dataset therefore excludes unsuccessful bids to
rule out this possibility.
10
Background
A thirsty country in the midst of rapid industrialization and urbanization
The People's Republic of China has experienced unprecedented growth since it initiated market
reforms in its economy in 1978. Its GDP has grown at an average of 10 percent a year, lifting more
than 500 million people out of poverty, 5 amidst the themes of rapid industrial development, and the
accelerated urbanization that accompanies industrialization. The development of China's economy
has raised a growing middle class and resulted in significant improvements to the living standards of
its population, but it has also come at a high environmental cost, including an increasingly overused
and polluted water supply in China.
Home to nearly 20 percent of the world's population, China has access to only 7 percent of available
freshwater.6 According to United Nations estimates, the amount of water available per person is
2,079 cubic meter/year (2009), just one quarter of the world average 7 and amongst the lowest for a
major country. Demand for clean freshwater has surged throughout the country, and has outstripped
its supply, with more than 15 million Chinese entering urban areas each year, 8 and its burgeoning
industrial and energy sectors. China's Ministry of Water Resources reports that of a total of 663 cities
in China, more than 400 cities face water shortages, and 110 of these are 'severe'. 9
Year
Population Urbanization Level
Total
(million)
Urban Population
(million)
2010
2030
1,341
1,393
660
957
49.2%
68.7%
Water plays a critical role in fuelling China's growth, as it is essential not only in quenching the thirst
of China's 1.3 billion strong population, but also in producing sufficient food, and the energy that
powers all of China's cities and industry. Agriculture currently accounts for some 65 percent of total
water use in China, and in addition to meeting the growing demand for food, its export-oriented
industry's ever greater need for energy requires greater volumes of water for thermal power
generation.
It is important to understand the nexus between water and energy. A large amount of energy is
required in the treatment and transportation of water, and increasing amounts of water is required
with the continuation of China's industrialization and urbanization trends, as water is also an
essential resource for many industrial operations, including coal mining, petroleum refining, cement
and steel production, and semi-conductor manufacturing, to name a few.
At the same time, 97 percent of China's power generation is reliant on a steady supply of water,
making power generation by far the heaviest industrial user of water in China. To power its industries,
China plans to double its 2010 energy-generation capacity by 2030, and due to the geographical
limitations of wind and solar power, much of this increase will come from water-reliant power
generation facilities such as nuclear, coal, and gas power plants.
The inter-reliance of water and power is therefore obvious; clean water cannot be delivered without
power and power cannot be generated without water. As can be seen from Figure 1, China's industrial
sector is expected to have the greatest increase in demand for water over the next 15 years.
11
The water supply-demand gap
The 2030 Water Resources Group projected 10 that if China's water demand continued rising at its
current rate of 1.6% a year, this demand would reach 818 billion cubic meters by 2030, outstripping
all available supply, which currently stands at around 620 billion cubic meters. As it is, demand has
already exceeded supply in many areas, and consequently, groundwater reserves that have
accumulated over thousands of years are being drawn down in a matter of decades by this deficit.
Water demand by sector
CAGR
2006-30
Percent
818
Murgdpal &
Domestic
Agriculture
358
385
420
0.6
Fkxod-affected
2005
2015
2030
provinces
provinces
Drought-affected
Provinces affected by
droughts &floods
Figure 1: Water demand in China. (left) Water demand by sector,2005 - 2030. (right) Uneven distribution of water stressed
provinces in China
Moreover, China's water is distributed unevenly across its geography. North China is home to over
45 percent of China's population and is the engine of the country's economic growth, contributing
almost half the nation's GDP, yet only receives less than a fifth of the water resources of the water-
abundant south. This uneven distribution of water supply between northern and southern China is
a major factor in China's low per capita water availability. The Chinese government has resorted to
constructing the massive USD 77 billion South-North Water Diversion Project (SNWDP), which when
completed, will transport 45 billion cubic meters of water from the Yangtze River basin to the
parched north of China annually through more than 2,500km of canals.
China's government clearly recognizes the risks of this supply-demand gap, and turned the country's
priorities for 2011 towards building water efficiency in agriculture, increasing water infrastructure
spending, as well as setting water usage caps in its "Number One Document", which lays out the top
policy agenda for the year.
Rapidly falling groundwater table exposes severity of the scarcity
As surface water resources are used faster than they can be replenished, many rivers, lakes and
wetlands have dried up. Farmers and industrial users therefore turn to sinking deeper wells and
pumping groundwater reserves to meet their water needs. In the arid north, many groundwater
aquifers are over-extracted and depletion is growing at an alarming rate. 11 In some areas, this has
led to an increase in arsenic and fluoride poisoning, as wells are sunk into deep aquifers tainted with
12
naturally-occurring contaminants. According to China's Ministry of Health, arsenic has been found in
the groundwater in about half the country's provinces. 12 Over-extraction of groundwater also causes
land subsidence, reducing the groundwater storage capacity of the depleted aquifer, and damaging
buildings and bridges. In coastal areas, over-extraction can also result in saltwater intrusion,
rendering the water supply unfit for drinking or agricultural use.
Pollution worsens water scarcity
Compounding the problem, clean water resources continue to dwindle as they become increasingly
polluted, further widening the supply-demand gap. Even water transfer projects such as the SNWDP
are rendered ineffective when the water transported is overly polluted. End-of-pipe strategies and
inadequate attention to early prevention and management has led to contamination from untreated
industrial and municipal discharge into rivers, as well as non-point sources such as agricultural
runoff. China's unsynchronized development of its environmental protection policy with its economy
has resulted in systemic issues where there is a lot more incentive to have wastewater discharged
untreated and to pollute the environment, than it is to build infrastructure that can safely deal with
the wastewater. The pursuit of economic gain had a deferred environmental and social cost to China,
which has now resurfaced as one of the country's most pressing issues.
The Chinese government's 2012 estimates indicated that 39 percent of major rivers and lakes, and
57 percent of groundwater was unfit for human consumption, 13 and 21 percent of available surface
water was unfit even for agriculture, but many of these continue to be used as a water source, leading
to the increased incidence of illnesses such as cancers in a grievous number of villages. 14
The need for water and wastewater treatment infrastructure
The magnitude of China's water woes requires urgent systemic change to improve not only the
policies governing this limited natural resource, but also the infrastructure that underpins its proper
management. Current water treatment infrastructure is inadequate to meet the demands of
continued industrialization and urbanization in China, in order to ensure continued development of
its economic objectives, social needs, and environmental sustainability in the coming years, and it is
here that foreign private sector players have both the capital and the expertise that is needed to
address the water woes of China.
Vast improvements in water productivity in industry and domestic use must be achieved by
upgrading industrial equipment with water saving technology and by fixing leaks in pipe networks.
While over 98 percent of urban Chinese residents have access to improved drinking water sources,
15 the country still needs to upgrade its aged water infrastructure to handle the higher domestic
water demand that accompanies urbanization. The World Bank estimates indicate that at least a
quarter of China's water distribution networks do not provide sufficient water pressure to 40 percent
of their respective service areas, and water losses add up to 20 percent on average, through pipe
leakage in the distribution networks of old urban water pipes. 16 Improving the distribution network
is where the most significant savings from efficient management usually arises, as it sharply reduces
water losses and has strong potential to stave off further expansion of water production capacity and
minimize the energy wasted in treating and pumping the leaked water.
Development of environmental regulations and a strong enforcement capability is needed to control
the worsening water pollution problem, and must also be developed in tandem with wastewater
treatment infrastructure to address the huge gap in wastewater production and wastewater
13
treatment capacity. The World Bank reported that insufficient investment in infrastructure
contributed to China's failure to meet pollution control targets. 17 By 2012, China's annual sewage
discharge production reached 41.6 billion cubic meters, but only 23 percent of it was treated to reach
national sewage discharge standards; the rest was discharged into the environment at suboptimal
quality levels. 18 This illustrates China's urgent need to improve wastewater infrastructure, along
with more water reuse plants to increase the supply of useable water resources in China. China's
central government has already set aside RMB 4 trillion (USD 635 billion) for the development of
water infrastructure between 2011 and 2020 in its twelfth five-year plan, to bolster the country's
water supply and distribution network, and raise wastewater treatment coverage across the country.
Urban water market structure
There are three main stages in which the private sector typically participates in China's urban water
services, as depicted in the diagram below. Opportunities for private sector participation vary based
on the particular stage involved and the size of the city where the project is located.
led Water
-
te
rametPa
t
PW
l
+
Ut
VIL~icipl
ityGovernrment
ipanr
(Bureau
Dirbution payments
WTP payment
Raw water
i
water scarcity charge + tap water charge
of Finance)
WWTP
Water Disrsbtio
payment
Wastwate Treadgen
sDhvrge
of waterDicag
-4Flow
-,
Flow of cash
Private Sector Participation
Figure2: Municipalwater market structure,highlighting the opportunities for private sector participation (in blue)
Water Treatment Plant (WTP)
Water treatment plants remove harmful contaminants in raw water and supply the purified water to
the water distribution network. WTPs were the first portions of China's water infrastructure that was
opened up to private sector participants, and there are no restrictions on the maximum
shareholdings of foreign companies involved in the investment, design, construction, operation, and
maintenance of WTPs.
WTPs were the first opportunities in the urban water sector that the Chinese government opened up
for private sector participation, due to the urgent need to support population growth in its large cities
in the 1990s. This can be observed from World Bank data as illustrated in Figure 15 within the "PPP
Activity Data" section. Along with permission for the private sector to be involved in WTPs came a
series of PPP policy changes to attract foreign investment as the Chinese state was in dire need of
capital for the large-scale construction of new WTPs to increase treated water capacities across its
14
major cities, as well as the rehabilitation of outdated WTPs; we elaborate on this in the "Development
of Water Policy" section.
Water Distribution Network
Water distribution networks provide for storage and distribution infrastructure such as storage
tanks and pipe networks to deliver treated water from WTPs to municipal consumers. This is owned
by a municipal utility company, which can be a joint venture company partially owned by private
sector participants. For large municipalities, foreign companies can take up a minority stake holding
of up to 49 percent in such joint ventures. For smaller cities, there are no similar restrictions on
maximum shareholdings. The municipal utility company is permitted to enter into concessions with
private contractors to manage the distribution network, including operating, maintaining, and
expanding the network, as well as end-user billing services.
Private sector participation in water distribution networks usually involves the WTPs that provide
treated water to the distribution network as well, an arrangement that is facilitated by concession
PPP modes, which is further explained in the "Types of Public-Private Partnership arrangements"
section. This integrated approach has effectively reduced non-revenue water (NRW) losses in cities
across China, particular with the involvement of foreign companies. 19
Private sector participation in water distribution therefore represents an important means through
which the private sector can contribute to improving the performance of urban water services. NRW
losses occur when payment is not received for water that is sent through the distribution network
for a variety of reasons, but mainly due to pipe leakage, inaccurate water meters, and illegal tapping
of water from the network. Considering that a cost is associated with each unit of water that is treated
and a cost is also associated with pumping water through the distribution network, the incentives for
the private operator to reduce non-revenue water losses is very strong compared to a publicly-run
utility that is not accountable for profit and loss considerations.
Wastewater treatment (WWTP)
Sewage from domestic and industrial sources are often mixed in the sewage collection network. The
WWTPs treat the sewage before either releasing it the water into the environment or further treating
the water for industrial reuse. Similar to WTPs, there are no restrictions on the maximum
shareholdings of foreign companies involved in the investment, design, construction, operation, and
maintenance of WWTPs.
Wastewater treatment rates have lagged treated water supply rates significantly. Domestic sewage
treatment rate increased from 52 percent to over 75 percent between 2005 and 2010, but much of
available wastewater treatment infrastructure is either outdated or inadequate for supporting
current levels of urban growth, resulting in 77 percent of the effluent from these plants not meeting
national sewage discharge standards. 12 Therefore, much of the focus of China's water infrastructure
development is now on boosting WWTP treatment capacity, and this is again illustrated in Figure 15.
15
PPP in the Chinese Water Sector
Starting from the 1980s, many developed and developing countries around the world began adopting
PPP models to develop and improve their public services. PPPs promised significant benefits to
consumers and their governments alike, including the use of private capital to finance urgentlyneeded infrastructure development, improving the efficiencies of public utilities, gaining access to
more advanced technologies and know-how in utility provision, and shifting commercial risks of
operating infrastructure to the private sector.
At that time, China had just shifted from a centrally-planned economy to a market-based one, so even
though it was badly in need of a massive infrastructure development effort, it only began opening up
to PPPs in the 1990s. Initially, China engaged the private sector primarily to mobilize financing, but
this precluded the introduction of private sector expertise in improving performance of water
services, and failed to attract private investors to smaller cities where infrastructure was most
undeveloped. Since then, it has experimented with numerous models for PPPs, and implemented
extensive policy reforms.
Types of Public-Private Partnership (PPP) arrangements
Different PPP arrangements spread the responsibilities and risks between the public authority and
the private entity are in different ways. Figure 3 summarizes the spectrum of private sector
participation in infrastructure projects in general, as well as the allocation of respective
responsibilities. The arrangements that are colored in blue indicate the arrangements in which
private sector involvement is commonly seen in China.
Public
owns assets
Private sector
owns assets
Public-Private Partnership
Arrangement
Private Sector
Participation
High
Commercial
RiskRikPublic
Capital
Investment
Public
Operations &
Maintenance
Public &
Private
Contract
1-2 years
(
Public
Mainly
Private
Private
Private
Public
Public
P
3-5 years
8-15 years
20-30 years
30-50 years
Indefinite
(5 y
t
Indefinite
Figure 3: The spectrum ofprivate public partnership arrangements in infrastructure projects
16
Operations and Maintenance (O&M) contracts
In O&M contracts, the private operator is generally paid a fixed or performance-based fee to run and
maintain the treatment facility. The operator is not in charge of tariff collection, and large capital
investment in equipment is the responsibility of the plant owner, which is the local water authority.
O&M contracts in China have only begun to appear more recently, and is more commonly seen in the
wastewater rather than the water supply sector.
Most O&M contracts around the world last for a term of 3 to 5 years, but in China, the contracts are
usually a lot longer, lasting 20 to 30 years. The long O&M contracts grants continuity to water services,
and facilitates more efficient management of water infrastructure assets because the private
operator engaged in long-term O&M contracts is inclined to provide better maintenance services to
minimize operations costs over the entire contract term. This is in contrast to shorter contracts
where the operator may not adequately maintain equipment, running down on the serviceable
lifetime of the equipment and necessitating costly equipment replacements that have to be borne by
the municipal authority that owns the plant.
Build-Operate-Transfer (BOT) and Transfer-Operate-Transfer (TOT) contracts
The Chinese government began permitting BOT and TOT contracts starting from 1994. BOT contracts
typically involve discreet treatment facilities, in which the private operator is fully responsible for
the investment required to construct the treatment facility. It then operates the facility for 20 to 30
years, recouping its capital investment and subsequently receiving returns on its investment from
the municipal government over the contract duration, based on the volume of water sent into the
water distribution network. In the case of a wastewater treatment facility, the private operator
receives payment based on the volume of wastewater treated.
In many BOT contracts, a minimum off-take volume is specified, so even if the volume of water
purchased by the municipality falls under the specified minimum off-take volume, the municipal
government continues to pay the private operator a specified fee, ensuring that their operations
remain viable. This is also known as a 'take-or-pay' scheme. At the end of the contract period,
ownership of the treatment facility is transferred to the public sector.
The TOT arrangement is very similar to that of a BOT, except that the private operator takes over an
existing treatment facility from the municipal government instead of greenfield development, and
may conduct some rehabilitation or upgrading work to the facility before operating it for the contract
period. The facility is also returned to the municipal government at the end of the contract. Because
TOTs are in many ways similar to BOTs, the term "BOT" will be used to represent both BOT and TOT
projects in the rest of this paper.
BOTs are one of the main forms of PPPs that Veolia and Suez are involved in in China, especially for
contracts established during the 1990s, before they were allowed to participate in full water service
concessions, and before domestic companies could participate in PPP projects.
Full water services concessions
In a full water service concession, the municipal government grants the private operator the right to
provide water supply services to the local community within a defined geographical area. The private
operator is responsible for the operation of all existing treatment facilities and the distribution
network, and has to invest in additional infrastructure if demand grows, to provide an adequate level
17
of water service within the concession area. Such expansion is favorable for the private operator, as
its revenue is obtained directly from the sale of water to consumers. Concession models for providing
water supply services can also include wastewater services, but concessions solely for wastewater
services are rare, because collection of wastewater is still seen as belonging to the public sector.
The private operator gets its revenue through the collection of water tariffs directly from consumers,
but at the same time, control of tariff levels rest with the municipal government. This provides the
private operator with strong incentives to improve the water distribution network to reduce nonrevenue water losses and maximize its revenues. Ultimately, all infrastructure ownership remains
with the authority, and revert under the authority's control at the end of the concession period.
While concessions provide the benefit of efficient integrated operation of a municipality's water
infrastructure, it also deserves special attention for its contribution to the politically sensitive issues
around water. Because as mentioned earlier, the private operator (an entity with profit and loss
obligations) interfaces directly with consumers when it bills and collects water tariffs from them, and
this emphasizes the economic nature of water provision, a concept that is not completely accepted.
We will further discuss his in the section on "the sensitivity of water provision".
For this reason, foreign companies are only permitted to hold a minority share of up to 49 percent in
the municipal water company that is granted the concession. Foreign operators usually enter these
concessions by forming joint ventures with domestic companies. The joint ventures formed thus
helps to reduce the financial risk for the foreign company as the risk is shared with the municipality
itself. Concessions are closely related to partial divestitures of municipal utilities in China due to the
time-bound nature of the divestitures.
It may be useful to note that the use of "concession" also applies to BOT structures in a number of
other literature on PPPs, due to the way that BOT projects are awarded to private operators for a
"concession period" but ownership is retained by municipal authorities. However, a BOT contract
involves building and managing discreet water treatment facilities and the bulk sale of water to the
local water supply company, and is significantly different from the management of a full water
concession in which water is sold directly to the end user, and the burden of collecting water tariffs
is also on the full water services concession operator. Therefore in the rest of this paper, the use of
the term "concession" will refer exclusively to full water service concessions, while BOTs will be
explicitly referred to as BOTs.
Concessions were the predominant PPP arrangement for both Veolia and Suez in the 2000s, as only
the larger and more experienced private operators had the capabilities to manage concession
contracts profitably, and as competition for BOT projects intensified with the entry of competition
from domestic water companies from 2002 onwards. Veolia in particular pursued large concession
contracts aggressively, as will be covered later in our discussion.
Partial Divestitures
In a partial divestiture, the private operator purchases a shareholding in a municipal water company.
Because water provision is a particularly sensitive matter, the Chinese government does not permit
foreign entities to hold a majority share in a municipal utility or to own water infrastructure
indefinitely. Therefore, all divestitures of Chinese municipal utilities are partial divestitures, with a
"time-bound" minority shareholding - the shares are returned to the municipal government at the
end of the contract period, a period that lasts up to 50 years. The partially-divested municipal water
company is in turn granted a concession equivalent to the time-bound shareholding period.
18
Veolia and Suez typically gained access to concession contracts through partial divestitures of
minority stakes in municipal water companies. In fact, around half of the PPPs in China's water sector
involve partial divestitures of municipal utilities company to private investors, though the reader
should bear in mind that to date, PPPs account for only around 10 percent of all the municipal water
infrastructure in China. In a partial divestiture, the capital invested goes to "purchase" the timebound shareholding from the municipal government and not into the joint venture itself.
Other PPP arrangements
Engineering, Procurement, and Construction (EPC) contracts are a mechanism by which engineering
design and construction of water infrastructure is contracted out to a private enterprise. Significant
costs accrue during construction of the infrastructure, so EPC contractors are adept at completing
construction activities within a relatively short timeframe. This facilitates the rapid development of
water infrastructure, and is one of the means by which advanced water treatment technologies held
by MNCs can be easily incorporated into the Chinese water infrastructure. The contracts usually last
no more than 2 years, so EPC contracts are outside the boundaries of our discussion as we are more
interested in looking at long-term PPP contract activity.
Other types of contracts include service contracts and lease contracts, but they are not common forms
of PPPs in China because they do not involve the injection of private capital - which would otherwise
allow municipal budgets to be deployed to other areas - nor do they generate incentives for
transferring know-how to domestic parties; these contract types are therefore less attractive for
municipalities. Also, the margins in these businesses are thin, and therefore do not generate as much
interest with foreign companies. As these contract types are not prevalent forms of PPP in China, they
will not be discussed in detail.
Main participants in China's urban water sector
Today, there are many private sector participants that are active in the Chinese water sector, and
they can be broadly classified as either foreign water companies or domestic water companies.
However, many foreign companies have established Chinese subsidiaries and Joint ventures with
domestic companies to hedge against risks following regulatory changes in 2002, and since then the
boundary between foreign and domestic companies has blurred considerably.
Multinational water companies (MNCs)
The MNCs comprise foreign private companies in the global water industry, and many are utilities or
construction conglomerates. MNCs were the first private sector players that were permitted by the
central government to participate in China's urban water services in the 1990s, and are often looked
upon as providers of leading-edge technology and best practices in operations and management.
MNCs have played a critical role in defining the landscape of private sector participation in China's
water sector, not only in terms of capital and technology, but also in their participation in key projects
that have helped the Chinese government to streamline policies relating to PPPs in the water industry.
Their capabilities span the entire range of activities in urban water services; including process
engineering, project financing, Engineering, Procurement & Construction (EPC), and Operations &
Maintenance (O&M). Veolia Water and Suez Environnement are two of the more prominent MNCs in
China, and we will take closer look at these two companies in the next section.
19
Domestic Water Companies
Domestic water companies are mostly state-owned enterprises (SOEs), and have been increasingly
active within the last decade, growing rapidly through aggressive acquisition of existing water
operations. They now dominate the Chinese water sector, competing for water projects at prices that
are difficult for MNCs to maintain. In general, domestic water companies enjoy stronger
governmental support than MNCs, especially as Chinese officials seek to nurture home-grown
enterprises to boost the local economy. According to Li, Poppo, and Zhou, 20 MNCs also suffer a
comparative disadvantage in extracting value from their interpersonal connections compared with
domestic firms, which puts the domestic firms in a much better position to access project
opportunities in Chinese provinces further inland, where water infrastructure is not as developed
compared to provinces along the coast.
Domestic water companies may be further categorized as originating from financial and nonfinancial institutions, though a recent consolidation trend in the industry have made it extremely
difficult to distinguish between the two.
*
Chinese investment developers
Chinese investment developers arise from financial institutions, and are considered quasiprivate developers; most have roots in SOEs that are partially listed on stock exchanges in
Shanghai and Hong Kong. They usually operate through joint ventures and full asset
acquisitions of municipal water companies, and have access to low-cost capital compared to
foreign players due to their linkage with state-owned banks. Many of the smaller financial
institutions who bid aggressively for water projects may not always have extensive
experience in the water sector. Prominent investment developers include Beijing Enterprises
Water Group, Ltd, Beijing Capital Co., and China Everbright International.
*
Chinese water engineering companies
The Chinese water engineering companies comprise local water departments or water
systems providers that have been privatized. In the 1990s when the water treatment industry
was picking up, many of these companies started out supplying water treatment systems or
operating treatment facilities in townships and small cities in areas that were not attractive
to MNCs, especially given the large municipal opportunities that were open exclusively to
foreign companies and not to local ones.
Over the years, these local water companies steadily closed the quality and experience gap
with their foreign counterparts, and by the time they were permitted to participate in PPP
projects, some were able to produce credible, though not cutting-edge, treatment systems at
much lower prices. They also hold some degree of privileged access to decision-makers when
they compete for projects in their home provinces, especially as Chinese officials seek to
nurture home-grown enterprises to boost the local economy. Many are now listed on stock
exchanges in Shanghai, Hong Kong, and Singapore. They include the Han Kore Environment
Tech Group and the Sound Global Group.
A strong consolidation trend amongst the domestic Chinese companies was seen in 2013, driven by
new market entry regulations arising from the experience the Chinese government has gained from
engaging in PPPs over two decades, enacted to avoid situations where additional government
expenditure is required in projects that are prematurely terminated or of subpar quality. The
20
requirements for contractors to submit performance bonds and have sufficient project references
are highly unfavorable to the growth of smaller companies, making them prime acquisition targets
for the large investment developer looking to expand their operations to attain greater scale. The
investment developers also boost internal technical capabilities by acquiring local water engineering
companies, increasing the flexibility and robustness of their operations, rivaling that of the MNCs.
Table 1 shows us some of the consolidation activity that occurred in 2013.
Table 1: Major brownfield project portfolio acquisitionsin the Chinese water sector in 2013 21
month
Acquiror
Feb
Sep
BEWG
BEWG
BEWG
BEWG
Oct
BEWG
Aug
Jan
Sino French
Heilongjiang Interchina
Jiangxi Sanchuan
Mar
Sep
Nov
Target
3 project companies with 7 WWTPs in Dongguan
Nanning City Dashatian Water Supply Co.,Ltd.
Crystal Water Company and China Water Holdings
Salcon Water (Asia) and Salcon Berhad China
project assets
Beijing Construction Engineering Group Environment Development Co., Ltd.
Chongzhou D"y) Water Purification Co., Ltd.
Qinhuangdao-based sewage treatment company
Stake
100%
80%
100%
100%
65%
25%
Price (RMBm) Target deseription
504.1
WWTPs
Water treatment and supply
N/A
36 water/wastewater projects
1,350
9 water plants (operational
955
capacity .06 million m3/d)
26 WWTPs with a total design
270
capacity of 937,500m3/d
600,000 p.e. WWTP
N/A
Sewage treatment company
22.85
Yingtan-based water supply company
22%
43.95
Water supply company
100%
N/A
WWTP and water reuse
100%
180.8
WWTP and property development
WWTPs In Tianjin, Beijing and
Hubei
WTP and WWTPs
WWTP
60%
WM
Dec
Jun
Jul
Jul
-
Tieling Hongauan Dayu Urban Sewage Treatment
Co. / Tieling Hongyuan Dayu Recycled Water Co.
Chongqing Kangda Beijing Urban Construction EnvironmentalProtection Investment & Development Co., Ltd.
China Water Affairs Guangdong Xincheng Environmental Investments
Group Co., Ltd.
China Water Affairs Handan Chengcheng Water Affairs Co., Ltd.
Equity in three WWTPs in Beijing owned by Beijing
Sound Global
Municipal Construction Co..Ltd.
Beijing Capital
100%
24.5
34.32%
100% 240
The sensitivity of water provision
Water is essential to life, having considerable impact on human health and industry, and the
environment in which societies operate. It therefore constitutes an essential public service whose
mismanagement can severely affect the political standing towards governments. For the same reason,
its allocation according to economic mechanisms is often rejected.
Next, the physical properties of water itself, namely its mobility and bulk, makes it difficult to manage.
Water flows naturally across territorial boundaries, so identifying and measuring exclusive right to
it, the basis of market economies, is difficult to establish and enforce. In addition, the cost of treating,
transporting, and storing water is high in relation to its generally perceived economic value at the
point of use, limiting the economic viability of transporting it over long distances and increasing the
susceptibility of water services to market failure. This necessitates greater government involvement
and imbues a natural monopoly on water services.
Thirdly, water resource management is complicated by the aggregate impact, in the form of
extraction and pollution, of many actors with access to the water resource, and establishing effective
policies to regulate a large number of scattered decision-makers can be extremely complicated.
These factors result in water being a highly sensitive subject, so the Chinese government has
maintained tight regulatory control and a cautious stance towards the privatization of water services.
21
It has also resulted in the extremely low water tariffs and the resultant underinvestment in water
infrastructure in China, as the tariffs - only until recently - could not support the cost of treated water
provision.
China holds mandatory public hearings when discussing raises to water tariffs - one of the first
institutionalized forms of participative policy-making in China. 22 While the public hearing process is
far from perfect, in light of the fact that the public was largely absent in Chinese policy-making
historically, it highlights the sensitivity of water tariff issues in China, one that could potentially cost
government officials much political capital if prices are raised too quickly or low-income group users
are not adequately considered.
Legislation on water
Given the country's size and the broad impact of water-related issues, the legislative framework for
China's water sector is understandably complex, with strong interdependencies across various
departments. At the national level, the main agencies involved in water management are the State
Council, which is responsible for issuing national policy statements, Ministry of Housing and UrbanRural Development (MOHURD, formerly known as the Ministry of Construction or MOC), the Ministry
of Water Resources (MWR), and the Ministry of Environmental Protection (MEP), and their specific
areas of responsibility are provided in Appendix A. Some of the policies contradict each other, while
others are subject to diverse interpretations by the various agencies. 23
Unlike many other countries that engaged in public utility privatization, China did not have in place
a well-established legislative framework to govern PPPs before engaging in them. Instead, the
Chinese government developed its market-oriented reforms through a somewhat experimental
approach, addressing specific issues in its policies as it learned from experience in a multitude of
pilot projects across its administration, 24 releasing governmental policy papers through the State
Council. This holds significant risk for private players, as policies can, and have been, changed
unilaterally without consultation with the private sector, binding foreign companies with fixed assets
in the country in an obsolescing bargain. Also, regulations and directives can be issued at the national,
provincial, and municipal levels, and different provinces could have different approving authorities,
procedures, and enforcement practices.
22
Development of Water Policy in China
Prior to 1978, water and sanitation services were managed under the centralized administration of
the Chinese government, which was also responsible for setting water tariffs across the country. The
provision of water services was virtually free of charge 2s because of the belief that water resources
were abundant in China, and that water was a public good and its provision was part of social welfare
under the socialist economy. 26
The economic reforms of 1978 opened the way for the gradual application of marketization and
decentralization of the Chinese economy, promoting accelerated industrialization, urbanization, and
population growth in China. Much of the urban water supply infrastructure constructed before the
1950s had deteriorated, and pipe breakages occurred frequently, resulting in losses and decreased
efficiency in water supply. Despite allocation of an enormous amount of public funds to boost China's
water services, poor management of already dated infrastructure, and the slow progress
municipality-financed construction of water infrastructure, adversely affected performance and
brought the shortcomings of the state-controlled supply augmentation approaches in urban water
supply to the fore.
China enacted its first comprehensive Water Resource Law in 1988, which established the broad
framework for the administrative management of water resources, aimed to address the
shortcomings of the fragmented water management system at the time. Water ownership and rights,
water use management, water quality protection and pollution prevention, a permit system for
withdrawals, and a water pricing system were among the major provisions introduced.
The 1988 Water Law facilitated the implementation of demand management 2 7 to tackle low water
usage efficiency in China - setting tariffs for water services to rectify the imbalance in water supply
and demand, and to a smaller degree, mitigate economic losses of its water services. 28 However,
heavy subsidy of water was still the norm, and the low tariffs charged for water services did not cover
the actual costs of water treatment, neither did it reflect the increasing scarcity of water resources in
China. In addition, the inefficiencies of state monopoly continued to present great difficulties in
building access to clean water supply and proper sanitation facilities, and water quality remained
poor. 29
China's prolonged challenges in urban water services and the short timescale it needed to be solved
led the Central Government to implement a series of market-oriented water policy reforms in the
1990s, including:
1.
2.
Economic Instruments a. Formal permission for private sector involvement in urban water services
b. Revision of water tariff rates and structure
Decentralization a. Delegation of responsibility for urban water services and water tariff decisions to
lower level governments
These reforms were part of a wider effort to modernize China's urban water services, and were aimed
at tackling some of its major weaknesses. The first, was underinvestment. Given the rapid
development, China's cities needed to adjust to the new spatial patterns of urban development and
looked to private sector participation to raise the investment needed to develop the crucial water
treatment infrastructure. Investment inflow would also allow China to increase the coverage of the
population served by water infrastructure, and improve the reliability of existing water supply. WHO
estimated that in 1990, only 57% of urban China was covered by sanitation services. 30
23
The second problem was the inefficient management of its water infrastructure, brought about by a
lack of operational expertise and also related to the lack of funds available for investment in efficiency
gains in operations. Given the rapid growth in demand for water services, China needed to rapidly
improve labor productivity and lower operating cost of urban water supply and wastewater
treatment. However, the state-owned enterprises (SOE) that were responsible for provision of water
services had little incentive to improve services because they were a monopoly and operated as a
subsidized public service, and thus, not fully accountable for the economic viability of the water
infrastructure.
Therefore, private sector participation in China's water services required a lot more than opening its
doors to private investment. There had to be economic incentives to attract foreign investors and
bring in modern management practices and technology transfers. Cost recovery through increased
water tariff rates was an integral part of this reform and had to be implemented hand in hand with
liberalization policies to attract increased private sector participation. There had to be a clearer
institutional framework so that private investors could assesses the performance and financial
viability of projects more transparently, and municipalities had clearer policy guidance and technical
support from the central government on how to develop the suitable models for private participation
in water. There had to be stronger regulations and better enforcement of the regulation to safeguard
the interests of investors, municipal water companies, and end-users alike.
Private Public Partnerships in China's urban water services
In the early 1990s, the central government enacted numerous regulations to promote private sector
participation in infrastructure development, including urban water services. This allowed municipal
water supply companies to enter into Public-Private Partnerships (PPP), though only foreign
investors were allowed to engage in these partnerships. This set the stage for foreign water
companies to participate not just in supplying technology and equipment, but also in engaging in
long-term investment opportunities in China's water sector. This early openness to private sector
involvement was a means of bringing in much-needed financing to the municipal water supply
companies through foreign equity, which allowed municipalities to employ their limited budgets in
constructing other service facilities to meet the needs of rapid urbanization and industrialization.
However, the management and operations of these joint ventures remained in the hands of municipal
water supply companies, and so urban water services continued to be plagued with the same
inefficiencies as before and little improved in the way of quality and access to water.
In 1994, the State Council published the Ordinanceon Urban Water Supply, 31 which emphasized the
private sector involvement in the urban water sector and the move towards sustainable cost recovery
in setting water tariffs. It also decentralized the water tariff decision making process to provinciallevel governments. 32
The central government also promulgated the Circularon Attracting ForeignInvestment through BOT
Approach 33 in 1994, and began adopting Build-Operate-Transfer (BOT) approaches to constructing
urban infrastructure, 34 such as power plants, highways, and water supply infrastructure. Most
project companies were organized as wholly foreign-owned entities (WFOE), which helped reduce
earlier concerns over conflicts of interest between the government's role as the regulator and owner
of project companies. The strong political support (especially in terms of the guarantee on currency
convertibility), stringent procurement procedures, and tighter contract structures (such as off-taker
credit support) of BOT arrangements increased private sector investment in infrastructure projects.
At the same time, they allowed multinational water companies (hereafter referred to as MNCs) to
bring in their operations and management skills.
24
However, the BOT schemes alone could not address fundamental operational deficiencies in China's
water services, especially since MNCs were prohibited from operating and managing urban water
distribution and sewage collection networks, as stipulated in the Interim Provisions on Guiding
ForeignInvestment Direction and the Cataloguefor the Guidance of Foreign Investment Industries of
1995. As mentioned earlier, improving the distribution and collection networks is where the most
significant savings from efficient management usually arises. Commercial management of metering
and collecting tariffs from end users usually increases water revenues without significant capital
expenditures as well. So the preclusion of MNCs from distribution networks had limited impact on
the improvement of China's urban water services.
Additionally, individual private investments rarely exceeded the USD 30 million threshold at which
State Development Planning Commission (now known as the National Development and Reform
Commission) approval was required, as the requirement for national-level approvals greatly
increased project risks, especially in delivery timeframe and its associated costs. These relatively
smaller projects were in turn not as attractive to MNCs.
Otherwise, the PPP agreements per se were favorable to foreign investors during this period, because
municipal governments placed great emphasis on attracting foreign investment. Many of the projects
funded by foreign capital had liberalized water tariffs, and a guaranteed investment return, which
conversely undermined the role of market competition in increasing the efficiency of the Chinese
water sector. So despite the many efforts of the government to promote public sector participation,
the complicated mechanisms of China's water resource management failed to enthuse widespread
private sector participation in water projects, and only 4 percent of the total investment in water
infrastructure was attributable to private capital between 1990 and 2000. 3
Major headway was made in 2002, when China amended the 1988 Water Resource Law, 36
integrating China's water management and administration on numerous fronts and fully developing
its market-oriented reform. Amongst the many establishments of the 2002 Water Resource Law, of
particular interest to our discussion are the liberalization of private sector participation in China's
urban water supply, and the implementation of a tiered water tariff system that allowed full cost
recovery for water supply services.
The amendment of the 2002 Water Resource Law was followed closely by the release of MOC's
Opinions on Accelerating the Marketization of Public Utilities (No.272 Policy Paperof the MOC, 2002).
Both foreign and domestic water companies were now free to participate in the Chinese water sector
through a multitude of PPP ownership arrangements, including joint ventures (JV), partial
divestitures of public assets, full service water concessions, Build-Operate-Transfer (BOT), and
Transfer-Operate-Transfer (TOT), alongside the existing state-owned water supply companies. Still,
BOTs remained the dominant PPP arrangement for a number of years.
Foreign water companies were previously only allowed to be involved in water distribution
networks in smaller cities. Now they were also allowed to participate in the expansion, operation,
and maintenance of water distribution networks in larger municipalities, which was attractive to the
foreign companies as it allowed them to diversify their revenues, and given the rapid pace of urban
development in China, represented significant opportunities for revenue growth. These changes
went beyond simply granting increased private sector participation in urban water services; the new
policies contained important clarifications on State ownership of water, and the inherent redefinition
of the role of the government and operators in the water sector.37
The State Council also issued the Notice on Appropriate Handling ofExisting Problemsin Guaranteeof
Foreign Investment Fixed Return Projects in 2002, which made guaranteed investment returns on
projects with foreign investment illegal, on the basis that it resulted in an unequitable distribution of
25
the benefits enjoyed by foreign investors and the risks born by domestic investors, and thus violated
regulations on Joint ventures and Sino-foreign cooperatives. This resulted in the renegotiation of
many PPP contracts, and led a number of foreign water companies to sell their shares in Chinese
water assets back to municipal governments. However, it corrected a major flaw in contract
structures, as a private operator receiving guaranteed investment returns would otherwise have no
strong incentive to increase the efficiency of their operations, undermining one of the main reasons
for engaging private operators in the first place.
Subsequent policy papers streamlined the development of PPPs, such as the Measures for the
Administrationof ConcessionaryOperationof Urban UtilitiesIndustries,38which was enacted in 2004,
essentially mandating that a public bidding process should be adhered to as part of procurement
procedures for urban water service contracts. Municipalities now usually invite a limited number of
private sector participants to bid on a selective basis for most tenders. Since then, similar policies
aimed at supporting the development of China's membrane sector, improving wastewater standards
to make it suitable for reuse, and continuing to raise and restructure water tariffs, have also been
released.
Most of the major regulations relating to PPP development in China's water sector were enacted by
2004, and can be referred to in Figure 5. The deregulation and large growth opportunities attracted
more private sector participation. By 2008, over 30 percent of China's urban water services had some
degree of private sector interests, 39 with a breakdown of about 20 percent of projects involving in
water utilities and 70 percent in wastewater utilities. 40 And China was a major driver for PPP
projects on a global scale. Between 2001 and 2012, China accounted for 61% of new private sector
water projects globally, 41 as illustrated in Figure 4. Furthermore, the government has announced
plans in its twelfth five-year plan to spend RMB 4 trillion (USD 635 billion) to further develop China's
water infrastructure between 2011 and 2020.
Now projecta
Water projects by region
90 70
60 501
40j
304
201
10
0
..11111111
i~iI 1
1991
1995
0 China
0 Latin America and the Caribbean
m Sub-Saharan Africa
2000
a Rest of East Asia and Pacific
0 Middle East and North Africa
2005
a Europe and Central Asia
* South Asia
2010
Figure 4: Global privatesector activity in water infrastructure,42
26
Year
1989
1991
1995
1995
1995
1997
1997
1998
1999
2002
2002
2002
2002
Title
The PRC Environmental Protection Law
The PRC Water and Soil Conservation Law
The Certain Matters Relating to Project Financing by Domestic Institutions Notice
The Several Issues Concerning the Examination. Approval and Administration
of Experimental Foreign Invested Concession Projects Circular (the BOT Circular)
The PRC Security Law
The Catalogue for Guiding Foreign Investment in Industry
The Administration of Project Financing Conducted Outside China's Tentative Procedures
(The Interim Procedures)
The Urban Water Price Regulation
The PRC Contract Law
The PRC Water Law (revised. first in 1988)
The Measures on the Guarantee of Fixed Profit Margins for Foreign Investment Projects
The Foreign Investment Industrial Guidance Catalogue
The Opinions Concerning the Acceleration of the Marketization of Urban Utilities
Industries
2004
2004
2004
2008
The Measures for the Administration of Concessionary Operation of Urban Utilities
Industries
Administrative Measures Concerning Urban Utilities Concession Rights
The Circular on Accelerating the Reform of Water Price. Promoting Water Saving and
Protecting Water Resource
The PRC Water Pollution Prevention Law (revised, first in 1984, revised in 1996)
Figure 5: Laws and regulations relating to PPP water projects in China
4
Water Tariff Reform
Another prominent feature of the Chinese water industry is the low water tariff rates in comparison
to other major economies. 44Due to water's characteristic as both a social and economic good, setting
an appropriate water price is not a straightforward process.
Since the founding of the People's Republic of China in 1949, water tariffs rates were established
directly by the central government at extremely low levels, as water provision was considered a
public service. The state-owned water supply companies did not participate in water tariff setting,
and there was no information disclosure or public participation in tariff decision-making process. 45
But as mentioned earlier, the central government realized that raising water tariffs was a crucial step
in attracting private investment and ensuring sufficient funding for China's urban water services, as
well as an important tool in reflecting the relative scarcity of water and encouraging water
conservation. They therefore took concrete steps to reform water tariff structures across the country,
which was accompanied by the installation of water meters at the household level; the first formal
water tariffs were collected in 1985. Still, given the poor quality of water provided by most municipal
water companies, it was difficult to implement tariff increases.
In addition to the 1994 Ordinance on Urban Water Supply that empowered provincial governments
to set cost-recovering water tariffs rates, the NPC Standing Committee also promulgated the Price
Law of People's Republic of China in 1997, which set a milestone in water tariff decision-making in
27
China. The 1997 Price Law allowed further decentralization of decision-making power to prefecturelevel governments, and broadened the stakeholders involved in decision-making to include water
supply companies, who were responsible for preparing water tariff plans, and the consumers of
water, through their participation in formal public hearings on the water tariff-setting process. 46The
1997 Price Law was a very significant development for China's water industry, as we will see in our
discussion of its effect on the nature of Veolia's and Suez's contracts in China in the "Further
Discussion" section.
The 1998 policy on the Administrative Method on Urban Water Supply Price,47was another major
development that operationalized the 1997 Price Law by defining water price structures and
measures for setting water supply prices and provided much stronger guidance for collecting water
tariffs. The 1999 Circularon Strengthening the Collection of Wastewater Treatment Tariffs called for
inclusion of wastewater treatment charges (WWTC) in the water tariff scheme, and it was to be set
at levels that covered operational and maintenance costs along with a moderate profit, indicating the
government's recognition of the need for more holistic view of water service costs in ensuring
sustainable water provision. As a consequence of these policies, the 1990s witnessed an annual
growth rate of the total water tariff of 16.5%, 48 with a tiered tariff structure implemented to different
extents across China, and special rates for low-income consumers to maintain access to water supply
even with the price increases.
Despite these measures, operating revenues were insufficient to cover the operating, maintenance,
and capital costs of a significant portion of China's water infrastructure, due to extremely low base
from which increases started. It must also be recognized that uncertainty still exists around tariff
increases, as central government regulation is applied at a differential rate across individual cities.
Municipalities tend to be more flexible in acting on these regulations, especially for water tariff
adjustments, which remains a politically-sensitive area.
According to the World Bank, as many as 60 percent of water supply services in China still made
financial losses in 2004, 49 and such utility companies would have had to be subsidized by the
government. This uncertainty around water tariffs was actually a strong incentive for privately-run
water companies to reduce non-revenue water losses in water distribution networks, but many
water companies that were not well run coped by cutting back on maintenance and deferring
expansion, which had the makings of a capability trap in which efficiency, service quality, and
reliability declined. 50 The State Council's 2004 Circularon accelerating the reform of water price,
promoting water saving and protecting water resource further emphasized the need to adjust the
water supply price to a rational level. 2004 also saw the promulgation of the Administrative Method
on Raw Water Price of Hydraulic Facilitiespolicy, replacing the 1985 tariff policy and revising the
label on water, from a public good to a commercial good, and therefore subject to commercial prices.
Even at present, water consumption typically accounts for an average of 1.2 percent of personal
income in China, while in Europe, that rate is 4 percent. 51 This indicates that there is still room for
an affordable increase of water tariffs in China, an increase that will improve water conservation and
help to attract more investment for water infrastructure. A 2013 survey conducted by Global Water
Intelligence, said the average water tariff (which includes charges for water and wastewater) in 25
major Chinese cities was USD 0.51 per cubic meter (the global average was USD 2.11 per cubic meter).
52
Steve Clark, CEO of Suez Environnement China said that the water supply services in many Chinese
cities are now financially viable without government subsidies. 53At the moment however, the tariffs
are not sufficient to support water that is supplied via desalination or the North-South Water
Diversion Project in the drier northeast of China - water from these sources still have to be subsidized
by the government so as not to stifle economic development. A progressive water pricing scheme will
28
be introduced by 2015, in which end users have to pay a water tariff that increases at an exponential
rate in relation to the amount of water used, and water-intensive industries will be encouraged to
recycle water with a higher tariff rate. As the country continues the tariff reform process across its
cities, it will continue to encourage more efficient water use and make more water treatment
technologies economically viable.
The raising of water tariffs will not only make new water treatment technologies viable, it will also
affect the attractiveness of the municipal water market to the private sector. While the political
sensitivity of raising water tariffs will only allow price increases to occur gradually, the increase
ultimately makes the Chinese water market more attractive to private sector participants, for both
MNCs and domestic water companies alike.
29
Veolia & Suez in China
Veolia Water
Veolia Water is a French water services operator that provides management of water and wastewater
services for municipal and industrial clients. It designs, constructs, and operates water and
wastewater treatment plants and distribution networks, as well as water reuse and desalination
plants. It is the water division of Veolia Environnement, which was formerly known as Vivendi
Environment, and its origins date back to 1853, when G6n6rale des Eaux was created by the imperial
decree of Napoleon III to supply water to the city of Lyons. Today, Veolia Water has close to 90,000
employees globally, and its 2012 revenue exceeded C10 billion. It supplies drinking water to 101
million people around the world, making it the largest water company globally.
The breakdown of Veolia Water's 2012 revenues by region is as follows:
France
Rest of Europe
%
Asia
Americas
Africa & Middle East
0%
5%
10%
15%
20%
25%
30%
35%
40%
Figure6: Veolia Water global revenue breakdown by geography.
Veolia Water in China
Veolia Water has more than 13,000 employees in China, and its water contracts serve over 43 million
people. 54 It maintains local offices in Beijing and Shanghai. It focuses on long term contracts in
municipalities with strong potential for growth. As such, it has aggressively pursued contracts in
provincial capitals, and its main municipal contracts involve full water service concessions in large
cities. ss
While Veolia first entered China in the early 1980s through its subsidiary OTV, Veolia Water only
started winning substantial projects in 1997, when it won its first Chinese water management
contract, a 20 year contract for the operation and maintenance of a water production facility in the
city of Tianjin. This was the first time the Chinese government allowed a foreign entity to operate an
existing water treatment plant.
Considering Veolia Water's comparatively late entry into the Chinese water market, it has been very
successful in building a strong project portfolio. In 1998, a consortium comprising Veolia Water and
Marubeni Corporation won the BOT contract for Factory B of Chengdu's No.6 waterworks. Veolia
Water was to build the Chengdu waterworks treatment plant, and operate and maintain the facility
30
for a period of 18 years, serving a population of 2.66 million in Chengdu. This was one of three
landmark PPP projects conducted under competitive bidding in China's infrastructure market. 56
Veolia's China Strategy
Veolia Water adopts an aggressive strategy in China, targeting long-term concession contracts in the
country's largest municipalities, 57 which puts it in a strategic position when these fast-growing
municipalities expand their water infrastructure's geographical coverage with the maturation of its
concession areas. The large concessions grant Veolia greater economies of scale and higher profits,
as further explained in the "Contract Types" discussion in the next section. Its strategic bidding in key
municipal areas is also expected to provide a foothold for expansion into the region surrounding
these provincial capitals, and also in anticipation of water tariffs increases.
Its strategy seems to be paying off; many of the municipalities where Veolia Water operates have
indeed increased their demand for water. The concession in Shanghai Pudong has seen a 50 percent
growth in water volume since it began operating in 2002. Veolia also received a significant extension
to its original 2003 contract in Shenzhen, along with water tariff increases that have at the same time
boosted Veolia Water's revenues. 58 Despite its aggressive approach towards China's water market,
none of its 25 contracts in China has been reneged. "It's fair that we could hope to double the number
of inhabitants we serve," said Antoine Fr6rot, Veolia Water CEO, in 2007.
Veolia is well known in China for outbidding competitors with a high premiums bid strategy. For
example, Veolia won an international bid to acquire 50% of the shares of Shanghai Pudong Water
Company in 2002, at a premium of over three times the net asset value of the portfolio's assets. The
acquisition was accompanied by a contract for a 50 year full water service concession, 59 which
included water production and distribution, as well as customer billing and services in the Shanghai
Pudong area. This was the first time a private company was allowed to offer full management of a
water distribution network including water tariff billing in a large Chinese munipality. The Shanghai
Pudong win was followed by the subsequent signing of numerous high profile full water services
contracts:
2003
*
50 year concession in Shenzhen in Guangdong province, a designated special
economic zone bordering Hong Kong.
2005
*
30 year concession in Kunming, the capital of Yunnan province.
30 year concession in Changzhou, a city adjacent to Shanghai.
*
2006
0
30 year concession in Liuzhou, the center of freight transportation in Guangxi
province.
2007
0
*
30 year concession in Lanzhou, the capital city of Gansu province.
30 year water and wastewater concession in Haikou, the capital city of Hainan
province. The entire province of Hainan is a designated special economic zone.
30 year concession in Tianjin municipality, a designated economic development
area.
*
31
Its bids for 49% interest in Tianjin Shibei Water Company and 45% interest of the Lanzhou Water
Supply Company were over three times the market value of the assets, and its bid for Lanzhou was
more than three times that of the next highest bidder, Sino-French, as illustrated in Figure 7 below.
The high premiums that Veolia pays to win large municipal contracts in China is representative of the
long time horizon it has on the investment returns for its concessions, as water tariffs only increase
gradually, and the increase in revenue from each concessions can only grow moderately with
population increases in those concession areas in the short run. Veolia must therefore be looking at
longer term growth of both water tariff and population growth due to urbanization, to earn the
returns that it places such high premiums on in winning concessions. This is confirmed by Antoine
Frdrot, CEO of Veolia Environnement. "The price we give in our bid is clearly very linked to our view
of the future. If we don't take into account the capacity of growth in the contract, we could not be
competitive."
Bids for Lanzhou Water Supply Co.
Bids for Tianjin Shibei Water Company
2,500
c
2,000
2,180
1,710
1,500
2,000
1,190
= 1,500
C9
920
c-
_-45
No~
.0 1,000
700
E~
500
000450
500
-8
5
Figure 7: Veolia Water's bidsfor large concession contractsin Tianjin and Lanzhou
Modus operandi
Veolia Environnement typically enters Chinese water supply contracts as an independent bidder,
avoiding the dilution of its shareholdings and the loss of control, but it has on occasion entered into
partnerships with local investment developers on a project basis. It has participated in numerous
partial divestitures, acquiring between 45 percent and 50 percent of a time-bound equity stake in the
municipal water supply company to manage the local water infrastructure for the duration of the
concession. The operation and maintenance (O&M) of the infrastructure within the concession is
subcontracted to a fully-owned or majority-owned subsidiary of Veolia Water. In this way, Veolia is
able to bring in its global water management experience and expertise to benefit local water services.
In fact, when Veolia enters such contracts, it is the O&M business that it pursues.
"The return on equity (in a municipal water supply company) is not so high because it is at a
Chinese level but we can leverage it a lot to get the O&M profit... The core competence of the
group is to be able to manage on a long-term basis the operation of water and wastewater
business."
- Antoine Frdrot, CEO of Veolia Environnement
The Shanghai Pudong contract structure is illustrated in Figure 8 below. Similar contract structures
were replicated in Veolia's Shenzhen (2004) and Lanzhou (2007) full water concession contracts.
32
r-- -
-
-
-
Shanghai
unicipal
Government
Opera te &
Maint ain
O&M fee
Veolia Water
-
+--
Shanghai Pudong Veolia
Water Supply Co. Ltd
- - --
---
I
50%
WAE TARIFF
Customer Billing
& Service
Concession
Contract
(50 year)
.
Shan ghai Water Assets
Managemn nt & Development Co.
ManaRe
Invest
....Distribute
Existing Water
Infrastructure
Figure 8: Shanghai Pudong Veolia Concession Model
New Water
Infrastructure
- - -+
-
g
Concessionary Relationship
Ownership
33
Suez Environnement
Suez Environnement is a French utility company that provides water treatment and waste
management services. It provides drinking water to 91.5 million people, 60 making it the second
largest global water services provider after Veolia Water. Its waste management services competes
directly with Veolia Environmental Services, another major division of Veolia Environnenment.
In the water sector, Suez Environnement designs, constructs, and operates water and wastewater
treatment plants and distribution networks, as well as water reuse and desalination plants. Its
history can be traced back to 1858, with the founding of Compagnie de Suez to finance the
development of the Suez Canal. Lyonnaise des Eaux, a French water supply company, merged with
Compagnie de Suez in 1997, to form Suez Lyonnaise des Eaux, which subsequently merged with Gaz
de France to form GDF Suez in 2008. The 2008 merger resulted in Suez Environnement becoming an
independent entity, though GDF Suez remains its largest shareholder, continuing to hold a 35.7
percent share capital in Suez Environnement. 61
Today, Suez Environnement has 80,000 employees in 70 countries, and revenue from its water
business amounted to C7.1 billion in 2013.
49% WATER - 51% WASTE
BREAKDOWN BY GEOGRAPHY
S49% Waftr
29% outside Europe
MORO
0 51% West.
EfW & other
Regulated
ASIA
-FRANCE
USA
recovery
Soring &
Recycling
Concessions
& O&M
-
AUSTRALIA
OTHER
EUROPE
UKSPAIN
GERMANY
&BENELUX.
i
Equipment
& Services
New
Services
Design &Build
Elimination
Services
35% Rest of Europe
J
Figure9: Suez Environnenent global revenue breakdown by geography and sector. 62
Suez Environnement In China
In China, Suez Environnement has over 7,000 employees and manages close to 30 water contracts,
providing drinking water to 15 million people through Sino-French Water, its JV company. 63 Suez
also provides infrastructure design and construction services through Degr6mont, and waste
collection and disposal services through SITA Waste Services, both of which are wholly-owned
subsidiaries of Suez Environnement. As we are interested mainly in the longer PPP water contracts,
we will focus on Suez's activities in China through Sino-French Water, which operates mainly under
BOT contracts and concession contracts.
34
-
100%
100%
NWS HOLDINGS LTD
DEGREMONT
M100%
SITA WASTE
=50%
SINO4RENCH HOLNGS
(HONG KONG)LTD.
3
WATER
85%MACAO
SUPPLY COXTD,
100%1
SINFNCH WATER
DEVELOPMENT CO-LTD
close to 30 contracts
Figure 10: Shareholding structure of Suez Environnementand New World Development in Sino-French Water
Sino-French Holdings was formed in 1985 as a partnership between Suez Environnement and New
World Services (NWS) Holdings,
64 which
is the infrastructure arm of New World Development, a
Hong Kong-based conglomerate. Both partners share 50 percent ownership of the JV, Sino-French
Holdings, and its wholly-owned subsidiary, Sino-French Water, as depicted in the diagram above. The
shareholders' agreement of Sino-French Holdings provides for equal representation on the
company's Board of Directors, as well as a right of first refusal that benefits the other shareholder
should one of the parties sell its holdings. 65
Also in 1985, Suez and NWS Holding formed the Macao Water Supply Company (Macao Water) and
began its first joint project in the region as the exclusive water services provider to Macao under a
25 year water supply agreement with the government of Macao. Macao Water was also in charge of
managing the city's water distribution network, and brought drinking water quality up to standards
comparable to municipal water standards in Europe, as well as dramatically reducing the nonrevenue water losses in Macao's distrubution network. 66
The success of Macao Water was instrumental in Sino-French's entry into mainland China in 1992,
when it established the Tanzhou Water Supply Company (Tanzhou Water) to run its first operations
in China. Tanzhou Water is 58 percent owned by Sino-French, and is the first Chinese-foreign water
supply joint venture company in China's water sector. The Tanzhou Township is just across the
border from Macao, and Macao Water demonstrated the effectiveness of Suez as a foreign company
bringing in technology and know-how, improving both the reliability and the quality of water
services. This played no small part in opening the way for Sino-French to establish the 35 year water
supply and distribution network management contract in Tanzhou. 67
Sino-French inked its first full water concession contract in a large Chinese municipality in Chongqing
in 2002, and went on to establish the Chongqing Sino-French Water Investment Company in 2006, a
50:50 joint venture with the Chongqing Water Group. Chongqing is a major transportation hub, and
since it became a directly-controlled municipality of the Chinese central government in 1997 has
grown to become the largest Chinese municipality and the only one of the four directly-controlled
municipalities situated in inland China; this was clearly a strategic win for Sino-French, to extend
35
greater reach into surrounding provinces in Western China. Chongqing Sino-French Water was also
the first Chinese-foreign investment holding company in China's water sector.
Sino-French acquired American firm Earth Tech's Chinese projects in 2009, a deal which arose from
AECOM's divestment of a large number of Earth Tech's global assets to Suez. The 3 projects thus
obtained are placed under Suez's Sino-French assets in China, but are associated more strongly with
Suez's global strategy rather than its China strategy.
Suez also acquired 65% of Shuangliu Dayi Environmental Technology in 2012, a private company
based in the Sichuan province, and this acquisition further extended Suez's reach into western China.
Suez's China Strategy
Suez focuses on winning contracts in many of the more wealthy provincial capitals of China, where
double-digit GDP growth is typical. 68 Provincial capitals serve as urban planning models in their
respective regions, and are used as reference projects to showcase how its water and wastewater
management expertise can benefit neighboring cities. The rapid pace of development in these cities
provide Suez the assurance of stable cash flows. However, it has not aggressively pursued the
extremely large concessions that Veolia typically goes after in tier-one cities, with the exception of its
concession in Chongqing, preferring instead to pursue a larger number of projects with smaller
contract sizes and limiting its capital investment, spreading the economic risks of its China portfolio.
This difference can be observed in the much lower premiums Suez is willing to pay for large
concession contracts as compared to Veolia (Figure 7), and it can also be seen in the profile of the
contracts Suez has entered, as discussed in "Scale of Operations" in the next section.
In comparison with Veolia Water, Suez takes a more cautious approach to China's water market,
continually ensuring that it is hedged against risks by limiting its employment of capital and
embedding itself in all of its operations through Sino-French. This approach serves to reduce its
financial risk and allows it to better adapt to the diverse conditions of local communities across the
many regions of China, 69 especially in developing projects further inland. However, Suez is also
diluted 50% in its control of each of its new projects in China, and also receives a lower profit for its
involvement in each contract.
Modus operandi
Suez selectively develops new concessions in water and wastewater treatment services in China
using its technological capabilities and the management expertise it has gained from operating water
infrastructure around the world, to improve local water services covered by its contracts.
Before requirements for municipal governments to engage in competitive bidding were established
in 2004, Sino-French typically engaged in direct negotiations with municipalities to develop water
projects. But it now has to participate in competitive bidding under the current PPP regulations.
Upon winning a project, Sino-French typically injects some foreign capital into its projects in Hong
Kong dollars, and then raises finance locally with its joint venture partner, and the design and
construction activity for new infrastructure development is subcontracted to Degr6mont. As
mentioned earlier, Suez handles all operations in China through the Sino-French JV structure, and
transfers its operational know-how to Sino-French. This is in contrast to Veolia, which does not
involve its local partners in operational management in China. Suez's arrangement of working
exclusively through the Sino-French subsidiary in China reinforces Suez's ability to access local
36
connections, and likely played a key role in establishment of its joint venture with Chongqing Water
in 2006. Suez's local entrenchment is also likely to pay dividends in terms of capturing growth
opportunities in the future, opportunities that it can only access through its partnerships.
Suez Environnement
50%5%
----
NWS Holdings
Sino-French Water
5%
(Joint Venture)
58%
Tanzhou
Municipal
Government
~
Concession
Contract
Cotrc
(35 year)
'
Tanzhou Municipal Economic
Devel opment Company
I
42%
Tanzhou Water Supply
Company Ltd
(Joint Venture)
|
Pr9flR00.
VVM I X-n
I MFA I I I
Customer Billing
& ServiceU
Operate
t ,n I Invest
|Maintain,
&Sevc
|Manage
Distribute
Existing Water
New Water
Infrastructure
Infrastructure
I
*Consumer
LEGEND
-
--
Concessionary Relationship
o Ownership
Figure 11: Tanzhou Water Supply Company concession model
37
PPP Activity Data
In this section, we will review the PPP contracts that both Veolia Water and Suez Environnement
have entered over the last two decades, in terms of the scale of operations and the types of PPP
arrangements.
Figure 12 shows the sum of new populations served by Veolia and Suez in major municipal water
contracts each company establishes each year, while Figure 13 shows the average population served
by these new contracts each company clinched in a given year. A tabulation of the details for each of
these major municipal water contracts can also be found in Appendices B and C.
Veolia Water served a total population of 44,690,000 people in 23 projects obtained from the time of
its entry into China in 1997, until 2012. This works out to an average project size of 1,943,043 people
served per project. Suez Environnement on the other hand served a total population of 17,753,500
in 27 projects in a longer time period, having entered its contract in the special administrative region
of Macao in 1985. This works out to an average project size of 657,537people served per project.
This information is presented in the table below, along with a breakdown of populations served
under each contract type by Veolia and Suez, whether it was an O&M, BOT, or concession contract;
as well as whether it was a water supply (WTP) project or a wastewater (WWTP) project. Neither
company entered O&M contracts for water supply, or wastewater-only concessions. This breakdown
is also presented graphically in Figure 14.
Figure 15 contains data on the new PPP projects for major private sector participants in China, from
the World Bank's Private Participation in Infrastructure (PPI) database. This gives us an idea of the
overall level of activity in the water PPP sector in China during the period of our analysis. In Figure
16, we look at the same PPI data as in Figure 15, but this time by arranging the projects according to
the type of private sector participants.
38
VEOLIA & SUEZ - NEW POPULATION SERVED IN CHINA
*
14
12
2002
- Revision of Water Resources Law
- Notice on Appropriate Handling of Existing
Problems in Guarantee of Foreign
Investment Fixed Return Projects
- Opinions on Accelerating the
Marketization of Public Utilities
-----------
10
a)
-a
0
-
-.
2004
- Measures for the Administration of
Concessionary Operation of Urban
Utilities Industries
- Circular on Accelerating the
Reform Of Water Price
8
1998 Administrative Method on
Urban Water Supply Price
0
6
9 1997 Price Law
Nov 2008
Chinese stimulus package
1994
- Ordinance on Urban Water Supply
- Circular on Attracting Foreign Investment
through BOT Approach
4
i1L
m
2
ill
N
N
I
I
I
I
I
I
I
I
I
I
I
I
I
I
I
II
II
#0
N~#
#~~
o
I
I
I1
~0NTN
EVeolia *Suez
Figure 12: New populationsserved by Veolia &Suez in China in the last two decades
39
VEOLIA
& SUEZ
- AVERAGE SIZE OF NEW PROJECTS
5
4
CL
w3
o 2
-
Veolia -
Suez
Figure13: Average populationserved by new contracts won by Veolia & Suez in China in the last two decades
Table 2: Breakdown of total population served by Veolia & Suez under each contract type
WTP BOT
8,510,000
19%
Full Water Concession (incl. wastewater)
28,690,000
64%
Veolia Water
WWTP O&M
270,000
1%
(23 projects)
WWTP BOT
7,220,000
16%
Total Population Served
44,690,000
100%
Average Project Size
1,943,043
I-WTP BOT
9,464,000
53%
5,890,000
33%
507,500
3%
WWTP BOT
2,010,000
11%
Total Population Served
17,871,500
100%
Average Project Size
638,268
Full Water Concession
Suez
WWTP O&M
Environnement
(28 projects)
40
VEOLIA - NEW CONTRACTS BY CONTRACT TYPE
12,000,000
10,000,000
8,000,000
6,000,000
4,000,000
2,000,000
MWTP BOT
a Full Water Concession
SUEZ
-
N Full Water & Wastewater Concession
U
WWTP O&M
BOT
U
WWTP
U
WWTP BOT
NEW CONTRACTS BY CONTRACT TYPE
5,000,000
4,000,000
3,000,000
2,000,000
1,000,000
0
MWTP BOT
m Full Water Concession
U
Full Water & Wastewater Concession
U
WWTP O&M
Figure 14: Veolia's & Suez's new contracts in China - breakdown by contracttype
41
NEW PPP CONTRACTS IN CHINA'S URBAN WATER SECTOR
50
U
Aj 40
40
02
Z
20
1994
1995
1996
1997
1998
1999
2000
2002
2001
U
Water
2003
U
2004
2005
2006
2007
2008
2009
2010
2011
2012
Wastewater
Figure 15: New PPPcontracts in China's urban water sector - breakdown by sector
3 30
0
.. . .II. Lh
iii.
NEW PPP CONTRACTS IN CHINA'S URBAN WATER SECTOR
50
h
dJ
U,45
w40
0
lii
ii1ii
S30
c25
0 20
~15Ur
1994
1995
1996
1997
1998
1999
2000
2001
2002
U
Domestic
2003
U
2004
2005
2006
2007
2008
2009
2010
2011
2012
MNC
Figure 16: New PPPcontracts in China'surban water sector - breakdown by projectsponsor
42
Further Discussion
Especially in China where regulatory uncertainty is not trivial 70 and regulatory practices differ
significantly between provinces, preparing a tender bid is a costly and time-consuming endeavor that
occupies valuable organizational resources, as it is difficult to complete necessary due diligence for
the large investments in new water infrastructure projects. Given this situation, Veolia and Suez have
to be strategic in deciding which projects to bid for. In this section, we will examine how the various
aspects of projects of each of the two companies entered were aligned, or could be explained by the
changes in the regulatory and market environment in China.
Scale of Operations
We look at the scale of operations of both Veolia and Suez in terms of two properties of the projects
each company entered; the average size of contracts, and the number of contracts. The projects taken
up by Veolia and Suez differ considerably in scale, and the averages in Table 2 provide an indication
of the scale of projects that each company targeted. Veolia's average of 1,943,043 people served per
project is almost three times that of Suez's 638,268 people served per project. It can also be seen
from Figure 13 that the average population served by Veolia's new contracts were significantly larger
than Suez's almost every year, evidencing the stronger focus Veolia places on winning large contracts
compared to Suez, and alludes to Veolia's higher risk appetite in entering the Chinese water market.
Next, we look at whether regulatory policies had an effect on the populations served by Veolia and
Suez's PPP contracts. By observing the trends in Figure 12, it may seem that the amendments to the
Water Resources Law in 2002 was the crucial turning point in the opening of large contract
opportunities to Veolia and Suez. Yet, as shown in Figure 13, the average size of Veolia's first projects
in Chinese water market in 1997 and 1998 were already noticeably large. Even Suez, as the earlier
entrant to China, began engaging in larger contracts in 1997. The most significant regulatory change
around that time was the introduction of the 1997 Price Law and 1998 Administrative Method on
Urban Water Supply Price. These two policies created the formal framework for municipal
governments to structure the pricing for water and charge water tariffs to consumers, by
empowering decentralized pricing decision-making down to the more granular prefecture-level.
More importantly, as we see from the increase in project activity in Figure 12 and Figure 13, the
promise of higher and more well-structured water pricing policies successfully attracted interest
from Veolia, which entered the Chinese PPP water market in 1997, and Suez, which increased the its
scale of operations in China, also in 1997. It is important to bear in mind that water tariffs were
below cost-recovery levels until recently and in some of the less developed cities tariffs have yet to
reach cost-recovering levels. Higher water tariffs meant that projects were less reliant on
government subsidies, and would become viable in many more cities, and it also gave private
companies greater confidence that its operations could turn in a profit.
One might wonder if the increase in activity in 1997 and 1998 is attributable to a situation where the
Chinese municipal authorities had simply bridled projects from private sector participation in the
prior years, but then made more projects available for development by MNCs starting from 1997.
This is not a likely scenario, considering the urgent need to boost water treatment infrastructure
across a large number of Chinese cities. Such a scenario would also contradict the State Council's (the
highest state administrative body) release of the Ordinanceon Urban Water Supply in 1994, which
sought to encourage private sector involvement in the urban water sector. The increase in the scale
of operations in both Veolia and Suez is thus best understood by the role that increased visibility over
profit-earning potential played in attracting private sector involvement.
43
Another observation we make from Figure 12 is the increase in the number of projects that Veolia
and Suez enter into after 2002. What is significant about this increase is that it reveals how both
companies held a long-term horizon in their entry into China, not pursuing short-term investment
returns by relying on the guaranteed investment returns that the Chinese government had previously
promised in PPP contracts but annulled in 2002. Instead, both Veolia and Suez begin to increase not
only the size of individual contracts, but also increase the number of contracts it engages in, even
after the release of the 2002 Notice on Appropriate Handling of Existing Problems in Guarantee of
ForeignInvestment Fixed Return Projectswhich made the guaranteed investment returns illegal. This
is in contrast to the termination of Thames Water's Dachang WTP contract in Shanghai, which is often
quoted as a representation of PPP model failure in China.
Contract type
63 percent of Veolia's population served in China involve concessions, compared with WTP and
WWTP BOT projects, which served a combined 36 percent of its population served. Suez, on the other
hand has 64 percent of its population served in China attributable to WTP and WWTP BOT projects,
and only 33 percent in concessions. This suggests that while both Veolia and Suez compete for
projects in China, their strategies are clearly different. It appears that Veolia has a much stronger
preference for large concessions, while Suez prefers lower-risk BOT projects.
Veolia has a majority of its projects in concession modes, in which it takes on a commercial risk,
balancing the capacity of all its water infrastructure with customer demand within its concessions,
and earning its revenues from direct collection of water tariffs from its customers. The commercial
risk stems from the fact that there are no guarantees of customer demand provided by the municipal
authority. Should it not be able to collect sufficient water tariffs from its customers, no matter
whether it is because water demand within the concession area drops, or it is unable to get customers
to pay the water tariffs. In either case, Veolia may not be able to recoup its investments in
infrastructure, let alone earn a profit. At the same time, heavy penalties are imposed on Veolia should
it fail to supply sufficient water to meet consumer demand.
Still, the PPP activity data shows us that once concession modes were permitted through the
amendment of the Water Resources Law in 2002, Veolia engages heavily in concessions, revealing its
preference for concessions over other contract types. This is because the returns from concession
contracts are higher compared with BOT and O&M contracts, especially for an experienced
concession operator with the know-how to optimize planning, operation, and management of all the
water infrastructure within its concession area. In fact, not all water companies are apt at managing,
or have the financial resources to manage, large concessions. Veolia, which serves the largest
combined population amongst all the water companies around the world, undoubtedly has such
know-how.
Veolia also mitigates its commercial risk by only entering concessions in large municipalities with a
strong local economy, where the probability of it not being able to collect sufficient water tariffs
within its concession area is lower. The risk inherent in a concession actually decreases the larger
the concession area is, as large cities tend to have more robust economies that attract increased
immigration - this is of course provided that the concession operator has access to sufficient capital
to support the high growth of the concession area. The strong economies of such cities not only
represent an assurance that water demand will grow; the diversified mix of industries in large cities
also means that the populations of these cities are more likely to remain stable. Operationally, a large
concession area enables Veolia to achieve economies of scale, as it can build larger treatment facilities
instead of many small ones, and its centralized systems for managing the entire distribution network
44
serves a greater number of people. These advantages make large concession contracts very attractive,
and Veolia clearly pursues them aggressively, its strong balance sheet enabling it to secure the
financing it needs to support its aggressive bids to win them. However, because concession contracts
are 30 to 50 years in duration, the commercial risk is still significant, especially considering the high
premiums Veolia has paid in many of its concession contract wins.
Suez also entered at least six concession contracts, though it can be seen from Figure 14 that these
concessions were much smaller than Veolia's. Concession contracts only began to appear in large
cities in China after 2002, when the Ministry of Construction released the Opinions on Accelerating
the Marketization of Public Utilities. But the Tanzhou concession established by Suez in 1992 was
allowed to proceed before the release of this policy, because Tanzhou was not considered a large
municipality.
It may be tempting to conclude that Suez's stronger WTP BOT project portfolio is representative of
its more cautious approach to the Chinese water market, given that BOT projects are generally less
risky compared to concession contracts - BOT operators are responsible for supplying a pre-defined
volume of water to the distribution network, and the minimum off-take volume specified in many
BOT contracts provides a measure of assurance to the operator.
However, an examination of the distribution of contract gains over time tells us otherwise. As we can
see in Figure 14, Suez's WTP BOT projects were mostly acquired before 2002. That BOT contracts
included take-or-pay guarantees does not seem to lead Suez to prefer WTP BOT contracts over
concessions; it gained only concession contracts once the Chinese government permitted higher
yielding concession contracts in large cities in 2002, and not BOT contracts. The WTP BOT contract
Suez gained in 2009 was from its acquisition of Earth Tech's assets, and factor into Suez's global
strategy more than its China strategy, as mentioned earlier in our discussion on Suez.
Moreover, Suez also began facing much stronger competition for WTP BOT projects after 2002, when
domestic water companies were permitted to participate in PPPs. Unlike in concessions, in BOT
projects it is the bidder who is able to achieve the lowest price for supplying water to municipal
authorities that usually wins the bid, and local companies frequently submitted water prices that
were in the region of 20 to 30 percent lower than the MNCs, 71 prices that the MNCs could not sustain,
given their higher overhead costs. In addition, fewer domestic water companies were precluded from
entering BOTs than concessions, as BOTs involved discreet assets with more predictable investment
requirements compared to concessions.
From these two observations, it is apparent that Suez's management of risks in the Chinese water
market is realized, whether by intent or by circumstances, more through its decision to limit its
capital investment by entering smaller municipal contracts, and entering such contracts together
with its local partners; not by its choice to pursue a higher percentage of BOT projects. We also begin
to see from this analysis how competitive pressure from domestic firms has begun to impinge on
Suez's contract wins, a pressure that eventually also affects Veolia significantly, as we discuss in the
next two sections.
Sector - Water & Wastewater
Given the rate of improvement in water supply coverage over the last two decades and the increasing
magnitude of its environmental problems, China is placing a strong focus on environmental issues.
China's 12th Five-Year Plan (2011-2015) set targets in sewage treatment and industrial pollution
management, including a directive to meet a target of an 85% treatment rate for urban wastewater,
and for the reuse of 20 percent of that treated wastewater. This will require the construction of more
45
wastewater infrastructure with advanced technology, and is projected to be worth close to USD 60
billion in investment.
In Figure 15, we can see that the number of new wastewater infrastructure projects has exceeded
that for water supply infrastructure amongst private sector participants in China's water market
since 2004. However, if we look for corresponding project wins by Veolia and Suez, we only see two
major wastewater contracts, both won by Veolia. The first is an extension of Veolia's 2003 full water
and wastewater in Shenzhen, so it is not strictly a new contract win. The second is a sludge treatment
BOT project in Hong Kong in 2009, and it must be noted that due to its status as a Special
Administrative Region, different PPP regulations apply in Hong Kong as compared to mainland China.
Again, details of these contracts can be found in Appendices B and C.
It is not plausible that either Veolia or Suez were unaware of the rising demand for wastewater or
were too occupied with gaining water concessions to pay attention. Henri Proglio, Chairman and CEO
of Veolia in 2004 was also the permanent economic advisor to the mayor of Beijing. Gerard Mestrallet,
Chairman and CEO of Suez, was also Chairman of the Chongqing Mayor's International Economic
Advisory Council. These two MNCs were clearly well connected in the Chinese political circles and
definitely in the know of major movements in the Chinese water industry even before many other
domestic private companies.
While there are a few smaller wastewater projects in Veolia and Suez's portfolio, the two companies
do not seem to be gaining new wastewater treatment contracts anywhere on the scale of what one
would expect to see given the large increase in focus on wastewater treatment, as the direction set
out in the 12th Five-Year Plan and the World Bank data suggests. This is in spite of the fact that both
companies are global leaders in the wastewater business as much as in the water supply business,
and both are looking to grow their business in China to offset low growth in European markets, where
a large portion of their operations are current situated, and both were politically well-connected in
China.
It must also be noted that most PPPs for the construction of wastewater facilities are structured as
BOT projects. Few wastewater concessions are granted in large Chinese cities, except where they
exist as combined water and wastewater concessions, because wastewater collection is still regarded
mainly as a public service. And as covered in our discussion on contract types, MNCs were not as
competitive as domestic companies once domestic companies were allowed to participate in PPP
projects, which explains the dearth of wastewater projects in Veolia and Suez's project portfolios.
Domestic Competition
In Figure 16, we start to see a plausible explanation for the paucity of new projects for Veolia and
Suez in China, not only in the wastewater sector, but in the municipal water industry on a whole.
Domestic water companies began to participate in PPP water contracts in late 2001 thanks to a
relaxation of the government's prohibition of domestic private companies participating in water
PPPs. These domestic companies continued to win a rapidly increasing number of contracts, and
began to take on the lion's share of new PPP water contracts starting from 2006.
With many domestic water companies criticized as technologically poor and lacking experience, and
numerous reports and studies concluding that domestic private companies did not significantly
improve water industry performance, such as the one by Wang, Wu, & Zheng, 72 7 the expectation
was that many domestic water companies would drop out of the PPP water market after a few years,
being unable to deliver satisfactory performance despite raising water prices.
46
However, the pattern of project data in the 10 years leading up to 2012 shows that the total number
of new PPP contracts actually increased gradually, peaking in 2007. While this is indeed followed by
a decrease in the number of projects won by domestic water companies after 2007, the same pattern
is observed for both regional water companies as well as MNCs. Still, the urgent need for water
infrastructure has not declined, as evidenced by the increasing attention of the State on investing in
water infrastructure that was expressed through numerous channels, including the 12th Five-Year
Plan, and in the 2011 No. 1 Document.
The slowdown in BOT and concession tenders from 2008 onwards can be attributed in part to the
Global Financial Crisis of 2008, which saw a strong decline in infrastructure development globally. In
response to the weakening economy, China's State Council announced a USD 586 billion economic
stimulus package to minimize the impact of the crisis, almost 40 percent of which was allocated to
public infrastructure development. The ready access to credit for public infrastructure under the
stimulus plan shifted development activity strongly towards the public sector, and a number of PPPs
that were previously being discussed with private sector participants were cancelled.
At the same time, there was in China an increased focus on building up local environmental services
companies, as local officials' sought to nurture local enterprises; their own prospects for promotion
being linked to economic development within their jurisdictions. This, coupled with prevalent
lowest-bid-wins practices in China, led to a strong preference for local water companies in public
procurement. So while the private sector in general saw a dearth of PPP projects, local water
companies still found opportunities to participate in the development of infrastructure, only not so
much in PPP arrangements. They were being engaged on a large scale to continue supplying the
country's urgent water infrastructure needs as subcontractors to Chinese investment developers,
many of whom had access to funding from the stimulus package. Many local water companies thus
grew rapidly during this time.
While the surge in public financing from the stimulus package has since abated, Veolia and Suez have
not seen a simultaneous increase in new PPP project wins. The relative quietness for Veolia and Suez
is not representative of the dynamism of China's current water market. There has been a strong and
rapid consolidation of the BOT market in 2013, as large Chinese investment developers acquire the
more fragmented local water companies to bring scale to their operations, and acquire core
technologies like reverse osmosis, energy recovery systems, and high-pressure pumps. The
consolidation is also driven by the Chinese government's two decades of procuring from the private
sector in China. There are now stricter requirements on private companies engaged using public
funds, such as mandating that contractors submit a performance bond, and have sufficient project
references and certified technical skills. Many of these requirements are highly unfavorable to the
growth of smaller companies, making them prime acquisition targets for the larger companies
looking to expand.
As a result, the Chinese water industry is now dominated by domestic water companies that compete
aggressively for water projects at prices that are difficult for the multinationals to maintain. The local
players enjoy stronger governmental support, and easier access to local financing than their
multinational counterparts, as many are state-owned or stated-controlled enterprises, result in an
increasingly challenging environment for Veolia and Suez, and depicts a situation that is familiar to
many other multinational companies that are active in China; their strategies continue to evolve in
tandem with the rapidly changing situation in China.
47
Prospects for MNCs
Large Chinese cities have experienced the population increases that Veolia and Suez have hoped for,
but the rapid economic growth that has attracted the population increase has also seen a decline in
the need for foreign investment to finance the construction or rehabilitation of water treatment
facilities in cities in eastern China, where local economies and urbanization trends were the most
advanced.
However, large concession contracts in which Veolia's and Suez's operational management
experience can bring marked improvement to municipal water services are now rare, and new
concession contracts have not been seen since Suez's 2008 concession in Chongqing, awarded
through Sino-French Water. Given the relatively high coverage of water supply services across
China's urban environments, coupled with China's heightened recognition that water is a strategic
resource and would therefore want to retain control over it, future opportunities for concession
contracts seems highly unlikely. But while Veolia and Suez may not have new municipal concessions,
both hold on to existing concessions that are of high quality, given the trend of rising water tariffs in
the most developed regions of China, and can yield sustained profits if run well. This is especially
true for Veolia.
It may therefore seem that the opportunities for MNCs lie further inland, but MNCs are in fact in a
disadvantaged position here. With the consolidation of domestic water companies, many are now of
substantial size and have the financial resources to aggressively pursue projects outside of their
home provinces, and are looking at growth opportunities in western China as well. Moreover, there
is not a strong need for advanced water treatment technology further inland - Chinese companies
already have the technology and expertise to build conventional WTP and WWTP that MNCs cannot
match in terms of cost.
This has forced MNCs to concentrate on projects that require specialized water treatment
technologies and whose clients require strong assurances of success, shifting the focus from the
municipal contracts to industrial water treatment systems where the demand for advanced
technology is higher. The industrial systems business in China, estimated by the Global Water
Intelligence to be worth USD 2.9 billion is currently eclipsed by municipal water, which is worth USD
58 billion. 7 However, there are not as many domestic companies that are active in the industrial
water sector at this point of time, and so this is an area with strong growth potential for MNCs.
Desalination is another possible area that requires technical capabilities that not as many Chinese
water companies have. However, current water tariff rates are simply too low for widespread
employment of desalination, so it will be limited to heavily urbanized cities such as Tianjin and
Shanghai that do not have any other water sources to tap on. In addition, the desalination operator
will continue to be reliant on government subsidies to run viably for many years before water tariffs
can support the costs of desalted water.
The standing committee of China's National People's Congress announced the "Clean Water Action
Plan" in March 2014, placing water pollution as a priority on the national agenda. Its measures
strengthen control over water pollution, raising water discharge quality requirements, imposing
heavier penalties for polluters, and increasing provincial officials' incentives to enforce
environmental regulations locally by aligning environmental metrics with their performance reviews.
This heralds an increased demand for industrial wastewater systems, and an opportunity for credible
suppliers to rapidly increase sales. To that extent, MNCs with proven track records in water services
in major industrial sites are at an advantage.
However, the MNCs' advantage will inevitably shrink, as evidenced by the many Chinese companies
that are already active in water reuse projects, and the ability to design, build, and run a water reuse
48
project viably represents a significant advancement in a company's technical capabilities. In addition,
China's strong focus on increasing research spending on desalination and water reuse technology
means that while MNCs may at the moment be able to leverage more advanced technology and their
global experience with desalination and water reuse, it will not be many years before Chinese
companies catch up, making it an uphill struggle for MNCs to stay ahead of the curve.
MNCs may still find growth opportunities, albeit smaller ones, by cooperating with domestic water
companies instead of competing squarely with them. Suez's and NWS Holdings' joint 13.44 percent
shareholding in Chongqing Water Group is an example of this. Unlike the partial divestitures of
municipal water companies that allow MNCs to gain access to the operational management of local
water infrastructure, Suez's involvement in the Chongqing Water Group is more of a strategic
shareholding. The state-owned Chongqing Water Group operates 32 WTPs and 35 WWTPs in
Chongqing, and aims to expand its operations into neighboring provinces in western China.
Chongqing Water's embedded local connections and its strong ability to tap into affordable financing
is a means for Suez to continue its growth in the westward push of China's municipal water sector,
and clearly the identification of the right state-owned company is crucial. The MNC must at the same
time be able to bring to the state-owned company what it lacks - advanced water treatment
technology.
49
Conclusion
In this paper, we have tracked the development of the Chinese municipal water sector to understand
how the market and regulatory environment has affected foreign water companies operating in
China.
We have explored the policy and regulatory changes governing both PPP arrangements and water
tariff reforms, granting permission for pilot projects in smaller cities before opening opportunities in
larger municipalities, with continuous releases of amendments to previous policies that responded
to their experiences in pilot PPP projects. Because projects of significant size had to be approved by
state authorities, the pace of development with foreign investment could be monitored and
controlled.
We also followed the new contract growth of Veolia and Suez in China to understand how the policy
evolution affected opportunities for foreign water companies. We observed how the 1997 Price Law
made larger contracts more attractive to both Veolia and Suez, but also how the fact that PPP projects
were limited to BOT arrangements in turn limited the number of projects that were of attractive to
foreign companies.
Subsequently, we saw the liberalization of policies surrounding PPP contract types and participation
restrictions in 2002, including the permission for private sector participants to enter full water
concessions in large municipalities, and for domestic water companies to participate in PPPs. These
moves increased the dynamism of the Chinese water market. Along with the greater investment that
followed came the availability of global technology and network management expertise, which raised
the standards for domestic water companies that were able to learn from the best practices of the
foreign companies as well. While the size, technological capabilities, and experience of MNCs
provided them with advantages in concessions and encouraged them - especially Veolia with its
higher risk appetite - to engage in a larger number of contracts in China, domestic water companies
became more competitive in BOT projects.
Veolia and Suez therefore did not seem to be able to capture much of the market with the transition
of focus to wastewater treatment in 2004, due to the fact that most of the wastewater projects were
structured as BOTs, and domestic companies had by this time exceeded the MNCs in their ability to
deliver both WTP and WWTP BOT projects at lower cost. Veolia and Suez were able to clinch good
quality concession projects, which will provide a more stable revenue stream as the contracts mature
and water tariffs in their respective concession areas rise.
Taking a step back from the actual events to look at the broader narrative, we see how the Chinese
government adopted an experimental approach towards developing its urban water sector, and also
in learning to build a "social market economy with Chinese characteristics." It first sought financing
for water infrastructure, by drawing in foreign direct investment with guaranteed investment
returns, but not allowing operational control. Realizing that financing was not sufficient, opportunity
was then gradually opened up for foreign companies with the necessary technology and capabilities
to participate in selected water infrastructure development opportunities, which allowed China to
streamline its policies and develop local capabilities.
Currently, capital is no longer the strongest limiting factor in developing its infrastructure and so
China is no longer in dire need of foreign direct investment. It has learnt how to structure meaningful
contracts to govern private sector participants in PPP contracts, and recognizes the value of water as
a strategic national asset. Domestic water companies are now adept at constructing conventional
water infrastructure, largely crowding out the more expensive foreign players from the municipal
market and squeezing them into niche technology applications in industrial water treatment, water
50
reuse, and desalination. But China has been investing heavily in research and development to
advance its water technologies, so it may be difficult for MNCs to maintain a strong technological
advantage.
The quality of opportunities for multinational companies in the Chinese water market, and other
sectors in which infrastructure can be developed through PPP arrangements - such as in power
generation, telecommunication, and transportation networks - is likely to have diminished
significantly, but they will not disappear. MNCs must continue to seek opportunities to establish
mutually-beneficial partnerships with large Chinese companies to sustain further growth in China
while they still hold a coveted advantage.
51
Appendix A: Water-related agencies in the Chinese government
Mkistby of Hou*ing Urben, nd
Urban water supply, urban wastewater treatment
Mis" of constbtion)
Ministry of Agriculture
Mstry of Lawd and Rnkspu.ss
State Forest Administration
hiftry ofmanwportsflon
State Oceanic Administration
wt " P"nlafpit C fgews
w*,r sean arc tualpluto f:orn ancemials
Rualan arlkjl~fa
Water as aresource, land use planning
U:in foea to onserve wtrsue
Ship transportation and water pollution control
'- "irn enion et
oleci. and conserve
i : se , w
Legislation, law enforvement, and supervision
I
I
I
U
U
52
Appendix B: Veolia's PPP contracts in China
Project
Sector
Contract
Type
Contract
Duration
1,850,000
Water
TOT
20 year
Lingzhuang, Tianjin
2,660,000
Water
BOT
18 years
600,000
Water
TOT
Chengdu, Sichuan
First international WTP BOT project in China
Baoji, Beijing
Start
Year
Populatio
Sened
1997
1998
991ya
,6_trT
25 year
6,__trT
2ye
Description
Rehabilitation and Operation
Rehabilitation, extension, and operation of two WTPs
Pudong, Shanghai
2002
2003
50 year
Won through international tender
Water
Concession
330,000
Wastewater
TOT
30 year
Zhuhai, Guangdong
Veolia's 1st WWTP
Rehabilitation and extension of 2 WWTP
7,610,000
Water &
wastewater
Concession
50 year
Shenzhen,Guangdong
Water & wastewater concession
270,000
Wastewater
O&M
20 year
Lugouqiao, Beijing
of Beijing's preparations for 2008 Olympic Games
3,600,000
__________
820,000
2,500,000
300,000
________Part
70,000
______
km distribution network
Wastewater
TOT
25 year
Ungrade and operation of 2 WWTP
Water
TOT
30 year
Hohhot, Inner Mongolian
Rehabilitation and operation of 10 WTPs
ate
300,00
TOT
22 ear
Weinan, Shaanxi
Water
TOT
22 year
TOT
35 year
Zunyi, Guizhou
23 year
Beiyuan, Beijing
2004
600,000
5 WTP, 4,200
Water
Wastewater
_________
_________
6_,__atr__
BOT
_________
ye
________Adjacent
ehabilitation and operation
Rehabilitation and operation of 2 urban WTP
to the Olympic Village
53
Start
Populatio
Project
Contract
Contract
Year
Sered
Sector
Type
Duration
1,200,000
Water
_________
_________
2005
2006
Concession
________
WTP, 1,750km distribution network
Water
W9
Concession
30 year
Kunming (provincial capital), Yunnan
WTP, 1,500km distribution network
1,200,000
Wastewater
TOT
23 year
Urumqi (provincial capital), Xinjiang Uyghur Autonomous Region
Upgrade and operation of WWTP
800,000
Wastewater
BOT
25 year
Water
Concession
1,000,000
4,100,000
30 year
_______4
ontrn,ct W
P
Liuzhou, Guangxi
WTP, 807km distribution network
wawater
(extension)
50 year
Shenzhen (extension), Guangdong
800,000
80,0
Water
W4
Concession
30 year
Lanzhou (provincial capital), Gansu
WTP, 640km distribution network
3,200,000
Water
Concession
30 year
Shibei, Tianjin
1,988km distribution network
Haikou, Hainan
3 WTP, 1,700 km distribution network
_________
3,000,000
2008
Changzhou, Jiangsu
3,500,000
3500
_________
2007
30 year
________5
Description
680,000
________WTP,
Water &
wastewater
Concession
30 year
Water
Concession
30 year
Changle, Fujian
Total Population Served: 44,690,000
54
Appendix C: Suez Environnement's PPP contracts in China
Start
Year
Populatio
Sered
Project
Sector
1985
540,000
198_4_,__
Water
Water_
_
Contract
Type
Contract
Duration
Concession
Concession_
25 + 20
year
Macao, Special Administrative Region
Contract renewed for a further 20 years in 2009
Description
1992
200,000
Water
Concession
35 year
Tanzhou-Zhongshan, Guangdong
1994
170,000
Water
BOT
30 year
Gaozhou-Maoming, Guangdong
1995
400,000
Water
BOT
30 year
Chongqing
1996
160,000
Water
BOT
28 year
Expandng, Jiang
1997
300,000
Water
BOT
30 year
[discontinued] Lianjiang, Guangdong
1998
1,200,000
Water
BOT
22 years
Dafeng-Zhongshan, Guangdong
100,000
Water
BOT
30 year
Changtu, Liaoning
118,000
Water
BOT
30 year
[discontinued] Siping, Jilin
Siping city filed for bankruptcy
1,400,000
Water
BOT
30 year
Zhengzhou, Henan
900,000
Water
BOT
20 year
Baoding, Hefei
146,000
Water
BOT
30 year
Xi
350,000
Water
BOT
30 year
Panjin, Liaoning
2000
2001
ang, Zhejiang
2002
55
Start
Populatio
Project
Contract
Contract
Sector
Type
Duration
2,500,000
Water
BOT
25 year
20,000
Water
BOT
50 year
20,000
Water
BOT
30 year
1,200,000
Water
Concession
50 year
Chongqing
2003
290,000
Water
Concession
30 year
Sanya, Hainan
2004
600,000
Water
Concession
30 years
Tanggu-Tianjin
2006
1,800,000
Water
Concession
30 years
Changshu-Suzhou, Jiangsu
2007
1,000,000
Wastewater
BOT
30 year
Tangjiatuo-Chongqing
1,500,000
Water
TOT
14 years
[acquired] Jieyuan-Tianjin,
Originally awarded to Earth Tech in May 2002
Upgrade and operate 1 WTP
1,200,000
Water
Concession
40 year
Yuelai-Chongqing
60,000
Water
Concession
30 years
[Acquired] Qinhuangdao, Changli, Hebei
Originally awarded to Earth Tech
610,000
Sludge
Treatment
BOT
30 years
Suzhou Industrial Park
Sino-French Water's first project specializing in sludge treatment in
China
400,000
Wastewater
O&M
20 years
[acquired] Guangzhou, Guangdong
Originally awarded to Earth Tech in 2003
Year
S
d
2002
2009
Description
ao, Shandong
Shanghai Chemical Industry Park
Also provides drinking water to domestic consumers
Shanghai SPARK, industrial water services
Also provides drinking water services to residents of the Spark
Development Zone and surrounding area
Sino-French Water's first full services venture for large municipalities
3 WTP, 549 km distribution network
3 WTP, 2,500 km distribution network
56
tart
Year
Populatio
Served
Project
Sector
Contract
Type
Contract
Duration
2010
70,000
Wastewate
10r
O&M
Md
unspecifie
2012
437,500
Wastewate
O&M
r
25 year
Description
Changxing Island, Dalian, Liaoning
2 WWT71p
Shuangliu-Dayi, Sichuan
8 rural WWTP
Total Population Served:
17,871,500
57
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