Private acquisition of municipal water system is under a new spotlight as utility giants plan to merge

Corporate mergers are nothing new; neither is the privatization of public utilities. But thanks to last month’s $40 billion merger announcement of American Water and Essential Utilities (also known as Aqua), the two largest municipal water and wastewater management companies in the U.S., Pennsylvanians are being confronted with what it means to be on the front lines of both trends – at the same time. 

Municipalities across the commonwealth, already treading water financially while overseeing aging water and sewer systems, are now fertile ground for private-sector utility companies to acquire local systems in exchange for cash up front. 

And while the details of the merger have yet to be determined, according to the press release, the move will allow both companies to “maintain an average customer water bill that is affordable (and support) the economic prosperity of the more than 2,000 communities in which the combined company will operate.”

Consumer advocates, on the other hand, worry what the merger will mean for ratepayers. 

“We just don’t know the impact that this acquisition is going to have on utility rates yet, but I would say it doesn’t particularly bode well for consumers to have one mega-utility serving most of the Commonwealth of Pennsylvania,” Patrick Cicero, of counsel to the Pennsylvania Utility Law Project and a former state consumer advocate, told City & State.

Private eyes

Pennsylvania – one of 15 states to have enacted “fair market value” laws to boost the sale price of water systems, according to the National Association of Water Companies – was already known among water companies and their shareholders as being industry-friendly. Since the passage of Act 12 of 2016, a statewide framework for utility sales, the state has seen even more local water systems acquired by private companies. 

According to the Public Utility Commission, 31 privatization cases have been filed since Act 12 took effect, with 25 acquisitions getting approval, three still pending, and three others either withdrawn, rejected or denied. Prior to Act 12’s passage, acquisitions of municipal utilities were relatively infrequent because systems were only allowed to be sold for their depreciated book value, which was not financially attractive to the utility companies and municipalities.

Act 12 mandates that the seller and prospective buyer each select an independent consultant from a group vetted by the state Public Utility Commission – the entity responsible for overseeing more than 150 water utilities statewide, most of which are privately owned. 

Consultants for each side have six months to calculate an estimated value of the water system based on its infrastructure, anticipated revenue, and costs for maintenance and improvements necessary to maintain compliance with health and safety regulations. 

The acquisition price is then determined by averaging the two estimates, unless the parties agree to a lower price, creating a pathway for higher figures than in deals prior to the passage of Act 12. 

With Act 12, the standard deduction for grants and other subsidies used on the systems over the years has been eliminated. At the same time, the system assessments can include income, which wasn’t the case before. 

Kimberly Barrow, vice chair of the PUC, said that prior to Act 12, the commission’s review of a potential acquisition was “pretty straightforward,” relying on depreciated original cost – the original cost of the assets minus the total accumulated depreciation – which, she said, is a “tenet of rate-making, historically.” 

“Now, instead of looking at the original cost, we’re looking at two figures,” Barrow told City & State. “It’s going to be the negotiated purchase price or it’s going to be the fair market value – the lesser of those two things … That can be completely divorced from the original cost minus depreciation.”

The end result is higher numbers for acquisitions, meaning more cash for municipalities seeking to sell off their assets and address long-term budget and debt obligations. But with higher agreements of sale comes the need for increasing usage rates, which are ultimately paid by residents who rely on the utility. 

“By allowing these kinds of valuations to be above original depreciated costs, it’s like (dangling) a carrot,” Barrow said. “It’s a way of getting the investor-owned utilities to actually want to buy them and put the money in.”

While acknowledging the importance of incentivizing prospective buyers to acquire failing or stressed municipal systems, Barrow said Act 12’s unintended consequences could result in rate spikes for low-income communities. 

Industry advocates argue that the statute benefits both the municipalities and potential buyers by presenting a more accurate picture of the utility’s value. They say that the previous framework’s valuations resulted in a lower probability that potential buyers would achieve an adequate return on investment. 

“For someone to suggest that purchase prices of acquisitions are the main driver of the costs associated with water and wastewater in Pennsylvania is not true,” Thom Chiomento, vice president of business development, government and external affairs at Pennsylvania American Water, told City & State. 

Pennsylvania American Water filed a rate adjustment request with the PUC on Nov. 14, saying it will help fund over $1.2 billion in critical infrastructure upgrades through June 2027. The planned upgrades, according to the press release, include eliminating lead service lines by 2037 and replacing 117 miles of aging water mains and 32 miles of aging wastewater mains.

The proposed statewide rate increases would cost around $10 more per month for sewer, $14 more per month for water and $20 per month more for customers of both. If approved, it would be the second increase for the utility’s residential customers this year.

Chiomento added that the large-scale customer service, material procurement and capital a private company can provide are necessary in many municipalities whose water systems are running out of capital. 

“It’s not cheap to run these systems and to invest in them and to get them to where they need to be from a compliance and an operational reliability perspective,” Chiomento told City & State. “So in order to do that, we have to invest dollars – and that is reflected in rates.”

Cicero, who pushed back against some water system acquisitions during his time as consumer advocate, argues that the statute “ties the hands” of the Public Utility Commission and leaves little wiggle room for debate over what he calls the “affirmative public benefit” that a sale is supposed to entail. 

“We made a mistake with Act 12,” Cicero said. “All that it’s done is inflate the value of systems for these private companies.

“Even if (utility companies) are being magnanimous about going in and trying to make a system better, the rates are going to go up. And although they have modest rate assistance programs, they’re fundamentally inadequate to ensure affordability,” Cicero added, noting that since 2016, water bills – which have risen as much as 166% – have cost commonwealth ratepayers an additional $100 million a year. 

Flood gates

Years of pushing infrastructure improvements and repairs down the line has led to many municipal or family-owned water systems developing regulatory and environmental problems, from leaks to chemical exposures that lead to boil-water advisories. 

Pennsylvania received a “C-” grade on the 2022 American Society of Civil Engineers report card, with its wastewater management score at the bottom with a “D-.” According to the U.S. Environmental Protection Agency’s 2023 Drinking Water Infrastructure Needs Survey, Pennsylvania is projected to require a $24.3 billion investment over the next two decades to modernize and maintain its drinking water systems. 

In some cases, private utility companies needed to step in via receivership to ensure that services continued in local systems, even before an acquisition process began. Companies like American Water or Essential can utilize their existing resources to support the system by providing necessary infrastructure investments. 

“Their local governments didn’t have the resources to properly invest in those systems. There was mismanagement on top of that, and those people suffered,” Chiomento told City & State. “People in poor communities tend to suffer when their governments don’t have the ability to invest in them.”

And for many municipally operated systems, the years of neglect coincide with artificially depressed rates because politically unpopular rate increases were also put off.

The combination of these crumbling systems and the regulatory environment created by Act 12 has led to more privatization and, in turn, private investment in struggling systems. For example, Pennsylvania American Water has plans to acquire six different systems in 2025 alone.

“What we bring to the table is, no matter who our customers are or what communities they live in, they get the benefit of our ability to invest,” Chiomento said. “We’re investing in those communities because we’re not bound by their local government’s budget.”

A municipality “may want to simply not (hold on to) the water and wastewater business. They may have municipal debt that they want to retire. They have other needs they want to pursue –  all of that makes abundant sense for municipalities,” Cicero said. “The question is whether or not it makes sense at all for the ratepayers of the acquiring utility to pay an excessive cost.”

Chiomento argued that the rate increases are just a sign of the times, pointing out the dire situations many systems are in and the artificially depressed rates municipalities have been charging utility customers over the years. 

“When people talk about these big rate increases because of acquisitions, what they’re talking about is the price they were paying before,” he said.

“When we’re acquiring (a municipality’s) customers, rates typically are going up. Why are they in that situation to begin with? Because they’re not charging the cost of service.”

Glass half-full

Harrisburg lawmakers have sought to reform Act 12, but to no avail. Some legislative proposals, including ones to put guardrails on private acquisitions and to cap the acquisition amount at 125% of the depreciated original cost, have been considered in the Capitol and have support from those who say consumers shouldn’t bear the brunt of the infrastructure investments. 

State Rep. Robert Matzie, who in 2023 introduced a legislative package during the previous legislative session aimed at reforming Act 12, said the results of the statute have “run far afield of that original intent.”

“(In) almost every instance to date, the municipalities or municipal authorities have exercised the provisions of the Act to sell healthy systems at amounts much greater than their current value,” Matzie said at the time in the co-sponsorship memo. “This has resulted in taxpayers and ratepayers being hit with exorbitant rate increases, with no discernible difference or improvement of service.”

Chiomento said industry stakeholders are “open to any modifications” to the statute, “as long as they improve the process, have a fair evaluation of these systems and they promote public input, transparency, and allow sufficient time for regulatory review.”

He also argued that the PUC – tasked with overseeing these deals and rate cases – exists to ensure that acquisitions like those by Pennsylvania American Water are prudent and reasonable. 

Barrow agreed, stating that she’s not worried about “utilities consolidating,” as long as the PUC “is doing its job” and ensuring that customer service remains affordable.

Cicero argues that the PUC needs to do more to ensure rates are equitable across communities and that ratepayers aren’t taking on more of the financial burden than necessary post-acquisition. 

“One of the main criticisms I have of the Public Utility Commission is they do not particularly hold utilities accountable on things like returns on equity, which seems problematic to me,” Cicero said, adding that “there has to be an affirmative public benefit” for an acquisition to be approved. 

The future of both public and private utilities in the commonwealth will continue to revolve around how water systems can be maintained and invested in while keeping rates reasonable for those using the water services. And now, as they revisit Act 12, lawmakers are expected to wade into the debate over repealing or reforming the statute. 

While acknowledging that reforms are needed, Barrow added that the regulatory environment must remain investor-friendly to ensure the state’s neglected water systems can attract buyers. 

“There’s a need for something like Act 12, but there’s also a need for some control on it as well,” she said, adding that a cap on the acquisition amount is a possibility. “Some form of a cap (may be necessary) because at the end of the day, it’s ratepayer-supported funds that are being used to buy these systems.” 

“It really is a balancing act, and Act 12 has the potential to help a lot of customers, like tens of thousands of customers throughout this commonwealth – it really does,” she told City & State. “We’re trying to do what we can (as the PUC), but we can’t change the act on our own.”