Private management and public finance in the Italian water industry: a marriage of convenience?

In many countries, reforms of water and sanitation utilities have favored private sector participation. The drivers of this trend are the need to improve efficiency, professional capabilities of service operations, and willingness to relieve public budgets of the heavy burden of investment. Scant attention has been devoted to the great impact this strategy can have on water bills because of the higher cost of capital that is implicit, given the economic risk that the private sector is required to accept. Since it is a capital-intensive industry with a long economic life of its assets, the water industry is particularly vulnerable to the cost of capital. This creates the case for publicly-supported financial schemes in order to keep this cost as low as possible and guarantee long-run viability as well as affordability. The Italian water industry is an excellent case study to investigate the importance of this situation: in the last 15 years, a far-reaching reform has been introduced with the aim of substituting a financing model, based entirely on public spending, with one delegating financial responsibilities to operators through full-cost recovery. Our simulations show that delegating all responsibilities and risks to the private sector can lead to unsustainable price increases once replacement of existing assets are required. The solution is not to give up full-cost recovery, but rather to search for risk allocation patterns that are more coherent with the risk profile of the water industry and help keeping the cost of capital low.