HKS415 PDF Eng

Kennedy School of Government HKS415
Case Program CR15-99-1482.0
Aguas de Cartagena:
The Privatization of Water in Cartagena, Colombia
Prologue
In July of 1997, near the end of his term as mayor, Guillermo Paniza contemplated the progress he
and his predecessor had made in improving the water and sewerage system of Cartagena, a city of roughly
750,000 inhabitants. Less than five years before, the public municipal services company responsible for the
system was suffering from chronic inefficiency, political corruption, financial chaos, intense union pressure,
and poor service delivery. By the end of Mayor Paniza’s term, a new company had been formed and a
private operator had assumed control of managing the city’s system. (See Exhibit I for a timeline of events).
This change had dramatically improved the administrative, technical and operational dimensions of the
city’s water and sewerage service. Residents were benefiting from improved customer service and better
water quality, as well as an increase in water supply.
Although pleased by these changes, the mayor was soberly aware of the substantial capital
financing challenges that remained. He also realized that opinion was divided on whether or not the city
could both find funding for the much-needed expansion of the network and maintain an appropriate level of
control over both the system and its private operator. Nevertheless, both Mayor Paniza and the former
mayor, who publicly agreed on little else, agreed on one thing: that the new company was serving residents
well.
Origins Of The Problem
Cartagena de Indias, gently pressed against the Caribbean Sea and surrounded by bays, swamps
and lagoons, was well known for its beauty and well loved by Colombians for its place in colonial history.
The walled old town, filled with restored churches, monasteries, and noble mansions with overhanging
balconies, as well as the city’s Caribbean upscale beach front and the nearby scuba diving islands had made
This case was written by Christa C. Erml, MPP ’98, under the supervision of Henry Lee. Antonio Almagro of the Inter
American Development Bank and Jose Gomez-Ibanez of the Kennedy School offered guidance and advice. It is based on
interviews and publicly available information and is intended for classroom discussion only and not to illustrate
effective or ineffective handling of an administrative or policy situation and does not represent the views of the World
Bank Group, the Government of Cartagena, or Aguas de Cartagena. (0798)
Copyright © 1999 by the President and Fellows of Harvard College. To order copies or request
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This document is authorized for use only in Rosa Amelia Gonzalez 's Empresa, Estado y sociedad ene-mar 17 course at IESA Venezuela, from December 2016 to March 2017.
Aguas de Cartagena ______________________________________________________CR15-99-1482.0
Cartagena a popular vacation spot for many since the early 1970s. By the mid-1990s, although tourism was
still the biggest industry, Cartagena was also Colombia’s second largest port and had become an important
petrochemical industrial center. This expanding economy, together with a general trend of urbanization in
Colombia, caused significant increases in Cartagena’s population during the late 1970s through the 1990s 1.
As a result of this continuous expansion, the city had been under constant pressure to improve and
expand its water and sewerage services. Unfortunately, it was during this critical time that the system
increasingly failed to meet the new needs of the city. By 1995, the water supply network reached only 70
percent of the city’s population, of which 42 percent experienced mild rationing and 20 percent experienced
severe rationing. 2 The sewer system serviced only 50 percent of Cartagena’s population, and the sewage
that was collected was deposited without treatment into the bodies of water that directly border the city, the
Bay of Cartagena and the Lagoon de la Virgen (see Exhibit II for Map).
The deficit in supply could not be attributed to a paucity of water from Cartagena’s principal water
source, the Canal del Dique. Built in colonial times, this canal was connected to the Magdalena, one of
Colombia’s major rivers. The water from the Magdalena, although highly contaminated from upstream
sewage, was plentiful. Once captured by the Canal del Dique, the water was directed to one of three plants
for treatment, 3 after which it was either stored in tanks or pumped into the city’s water distribution network.
Rates charged to residents for water and sewerage services were set at the national level and included
substantial cross subsidies across income groups. Nonetheless, it was generally agreed by city residents and
national officials that the root of the problem with Cartagena’s water and sewerage provision was poor
management by the public municipal company responsible for furnishing these services.
From 1961-1992, both water and sewerage services were supplied by Empresas Publicas
Municipales de Cartagena (EPM). 4 As demand for water and sewerage services increased in the 1970s and
1980s, the EPM was unable to maintain the system, which fell into a state of disrepair. This attrition was, in
large part, attributed to a corrupt relationship that had formed between the board of directors of the EPM
and Cartagena’s City Council. The directors of the EPM, who were appointed by the City Council,
increasingly used their positions to garner personal, financial and political benefits. In exchange for the City
Council’s implicit approval of such abuse of position, the board used company funds to finance Council
members’ election campaigns. This cycle led to administrative and financial recklessness within the
company, and operational disregard of the system. For example, the company had not made investments of
any kind since the early 1980s, which caused growing concern among residents that the EPM would be
unable to provide proper water and sewerage service. This concern was magnified by poor customer
service, high service charges and ever increasing rationing of water. 5
1 For example, the population of Cartagena had increased from 490,000 in 1985 to over 750,000 in 1995.
2 Mild rationing resulted in water service twelve to eighteen hours a day, seven days a week. Severe rationing
restricted water service to four to six hours a day, four days a week.
3 The plants implemented conventional treatment processes to clean the water: coagulation, flocculation,
sedimentation, filtration and disinfection (chlorination).
4 The EPM was also responsible for electricity supply, solid waste collection, and road construction and repair.
5 For further information regarding the water system before the privatization process, see Exhibit III.
2
By the early 1990s, the EPM’s difficulties worsened and the company’s water and sewage
operations were characterized by the following:
Technical Problems
• 30 percent of the already insufficient network needed major renovation.
• Majority of customers experienced mild to severe rationing.
• 52 percent of treated water lost during distribution. 6
• Environmental damage from depositing all of the city’s untreated sewage into the Bay of
Cartagena and the Lagoon de la Virgen.
Financial Problems
• Revenues were insufficient to cover operational costs.
• Company revenues unaccountably disappeared.
• Overall level of indebtedness increased to 155 percent over the value of the fixed and liquid
assets of the water and sewage system.
Administrative and Operational Problems

• Information regarding customers and billing was inconsistent and insufficient.
• Measurements and controls were almost totally absent.
• Tariffs were collected from only 40 to 45 percent of legally connected customers.
As a result of the problems, the National Planning Department, the Ministry of Development, the
World Bank and the District of Cartagena concluded by common agreement in early 1992 that no funding
assistance would be provided for the city’s water system unless real reform occurred.
Attempted Reform of the EPM
In light of the system’s problems and the external pressure to improve service to residents, Mayor
Gabriel Garcia Romero, who entered office in January of 1992 for a term of three years, decided to focus on
reforming the EPM. As Mr. Garcia stated, somewhat euphemistically, “By the time I took office, the EPM
was no longer serving the needs of our city well.” Given the relationship between the company and the City
Council, however, he believed that swift action against the company would be politically impossible.
Therefore, he dismissed the option of shutting down the company and establishing an entirely new public
company. Instead, Mr. Garcia decided to reform the company by gradually reducing its responsibilities and,
thereby, its importance and political power. On December 23, 1992, he issued a decree which changed the
legal nature of the company and ordered that the new entity, Empresas Publicas Distritales (EPD), only
furnish water, sewerage and sanitation service to the city. The other services previously furnished by the
EPM, such as, garbage collection and road construction and repair, were either reassigned to other
departments within the city or were subcontracted to private firms.
6 Acceptable expected rates of water loss during distribution range from 10 percent to 18 percent.
3
The union of the EPM employees, the National Worker Union of Public Service Employees
(SINTRAEMDES- one of the largest and most powerful unions in the country at that time), fiercely
opposed this restructuring. The city, in response, agreed to absorb all the employees that would otherwise
be displaced by formation of the EPD. This concession to the union meant that the EPD would hire 1,200 of
EPM’s 1800 employees. This concession was considered highly inefficient, since it obliged the EPD to hire
double the number of employees needed to run the city’s system. The Mayor, however, considered it a
necessary step to advance the reform process.
Once the EPD was formed in late 1992, removing the excess 600 employees from the payroll
became a high priority. Since a mass layoff would be an obvious breach in the agreement made between the
city and SINTRAEMDES, the Mayor believed that his only option for reducing the number of employees
was to offer a buyout-early retirement program. A program for voluntary retirement was designed by the
Mayor’s office, negotiated with the union, and thereafter approved by the EPD board of directors on May
19, 1993. The special program offered an immediate retirement pension, that for certain employees was as
high as 125 percent of the employee’s average salary plus a bonus of $2,500-$6,000 (1997 U.S. dollars). 7
The buyout-retirement program was considered generous overall and it quickly achieved its desired goal of
shrinking the number of employees on the payroll: six months after the program was implemented, in
December of 1993, the EPD had reduced its staff to only 532 employees.
This reduction in personnel, effected in the hopes of reducing costs and increasing efficiencies,
seemed to have no effect on improving system performance. The technical, operational and administrative
problems remained, and in some cases deteriorated. Furthermore, the company was in worse financial shape
than ever. Ironically, the company’s increasing financial woes could be attributed, in large part, to the
voluntary retirement program. First, the program dramatically increased pension premiums, which were
paid out of operating revenues and further stunted the company’s ability to maintain and invest in the
system. 8 Second, the legal basis of the voluntary retirement program was declared invalid by the
Constitutional Court of Colombia shortly. This decision triggered hundreds of former employees to file
labor suits and obliged the EPD to pay costly legal fees and court awards.
In addition, the EPD’s financial situation unraveled still further as a result of a new collective
bargaining agreement signed in 1993 between the EPD and its employees. The agreement granted
substantial additional benefits for EPD employees, including two consecutive annual raises in base salary of
23 percent each. According to one study conducted after the implementation of the agreement, the average
benefits, in addition to salary, had a value equal to two and a half times the salary itself. Also, the contract
granted unusually long vacations (up to two months per year) and short work days (six hours, accounting for
lunch and breaks), which further exacerbated the service delivery problems of the company.
7 This particular pension option was granted if individual qualified for retirement and had worked for the EPM for
at least ten years. Other, less generous packages (starting from bonuses of a few hundred dollars) were available
for those employees who were not eligible for retirement or who had worked less time for the company.
8 At its worst, the pension premiums consumed 40 percent of the EPD’s annual operating revenues.
4
The Liquidation of the EPD
Recognizing that the situation was unsustainable, Mayor Garcia concluded that the EPD should be
liquidated. In February of 1994, he met with Menahem Libhaber of the World Bank, and they discussed
how to proceed. Mr. Libhaber advised him to privatize the water sector, and it was agreed that the best form
of privatization would be to create a mixed capital company, 9 and have a private operator manage the entire
system under an operations and management contract (O&M contract).
Forming a mixed capital company was preferred to forming another municipal services company
because it would provide an opportunity to break the cycle of corruption that had formed under the EPM.
“Under the mixed company as we designed it,’ stated Mr. Garcia “the City Council would no longer appoint
the board of directors, and hence, the mutually beneficial relationship that had formed over the years would
no longer exist”. Hiring a private operator to manage the delivery of water services was considered
necessary because of the acutely needed technical expertise it could offer to improve the operation of the
system. “I had two reasons for preferring an O&M contract over a complete privatization agreement,” the
former mayor explains. “First, the city would still own the water and sewerage system, and this contract
would allay the fears of residents regarding private sector control of a public utility. Second, given the awful
condition of Cartagena’s water and sewerage system, I doubted that any private investor would think he
could make a return on his investment here”. In May of 1994, after intense outside pressure from the
national government and internal negotiations with the Mayor, the City Council reluctantly approved the
dissolution and liquidation of the EPD, and empowered the mayor to incorporate a new mixed capital
company to operate the system.
Regulatory Foundations of the Privatization Effort
From a regulatory perspective, the time to privatize Cartagena’s water and sewerage system had
never been better. From the 1930s and up until the early 1990s, Colombia, like many Latin American
countries, supported state intervention in the economy and strong protectionism. Although this system of
governing improved the socio-economic indicators in Colombia for many years, it became inflexible and
economically harmful by the early 1980s. The state’s highly centralized framework also contributed to
excessive growth of patronage and corruption. These problems of Colombian institutions contributed to the
intensification of violence as a political alternative and affected the legitimacy of the political regime. 10
In 1991, in an attempt to reform the government and to restore its legitimacy, Colombia adopted a
new development strategy. Privatization, decentralization, financial reforms, labor reforms, and changes in
foreign investment regulation were at the core of this strategy. In the same year, a new political constitution
was approved that included the legal basis for the participation of the private sector in areas traditionally
9 A mixed capital company has part of its stock owned by private investors, and part of its stock owned by public
entities. In this case, the private operator and other local investors would be the private sector stockholders and
the city of Cartagena would be the public stockholder.
10 Contents largely summarized from “The Privatization Process in Colombia: Some Political Issues”, Daniel
Rivera; Center for International Development Research, Terry Sandford Institute of Public Policy, Duke
University, 1996; working paper series DUK 100 96-001.
5
controlled by the state. From this foundation, the National Congress approved the Law of Public Services
(Law 142), in April of 1994. This law established the principles governing private sector participation in the
management, operation and financing of public services in Colombia.
Although the city of Cartagena was able to use this new law and development strategy as a
foundation for its privatization efforts, it would have to do so without precedents: Cartagena was the first
city in Colombia to privatize a public service. As such, several national and supranational institutions
became involved. An additional challenge surfaced in that Mayor Garcia who was considered the architect
of the city’s privatization process, was nearing the end of his term in office. Given that it was unlawful in
Cartagena for a mayor to seek re-election for a consecutive term, 11 there was an interest in advancing the
process as much as possible before the Mayor left office.
The Bid
Mindful of the time pressures, Cartagena opened the public bid in May of 1994. Three
international companies responded by purchasing the bidding documents: 1) Compagnie Generale des Eaux
of France, 2) Aguas de Barcelona of Spain, 12 and 3) North West Water Company of England. The primary
dimension along which the competitors were supposed to bid was the lowest cost at which each bidder
could ensure high quality water and sewerage services to the city and rehabilitate the system to proper
working order. Yet, because the system was in such disrepair, the city could give no reasonable estimate to
potential bidders of what would have to be done to meet these requirements and the costs of such actions.
Thus, the negotiations on these issues had to be kept very general. Representatives of the private firms
visited Cartagena to investigate the situation in June. However, only Aguas de Barcelona submitted a
proposal. According to Menahem Libhaber of the World Bank, “North West did not respond to the bid
because the company decided to focus its investments in Argentina rather than Colombia, and Compagnie
Generale des Eaux simply thought it was a bad investment because the system needed so much
improvement”. However, members of Aguas de Barcelona were not discouraged. “The risks, from our
perspective, did not seem large. Furthermore, we felt we could make the system work,” stated Luis Albacete
Perea, a representative of Aguas de Barcelona.
From September to December of 1994, when it was clear that only Aguas de Barcelona would
submit a bid, the process evolved into negotiating the O&M contract between the company and the city of
Cartagena. During this time, strong resistance to the city’s privatization efforts was surfacing from several
fronts. First, the unionized workers of the EPD placed intense political pressure on the city, in the interest of
keeping their positions and retaining all of the benefits received in the 1993 collective bargaining
agreement. 13 Second, members of the residents’ committees from the 15 wards of the city were worried
11 Although a person may serve as mayor for more than one term overall.
12 Aguas de Barcelona is partially owned by the large French water company, Lyonaisse des Eaux SA.
13 For example, when the City Council approved the liquidation of the EPD in May of 1994, the pressure from the
union reached such a violent intensity that the City Council members were forced to escape through the back of
City Hall.
6
about possible rate increases, and were opposed to foreign management of the city’s water system. 14 Third,
the new mayor, Guillermo Paniza, who would start his term on January 1, 1995, was skeptical. Mr. Paniza
defined his mayoral campaign by accusing Mr. Garcia of corruption and the financial bankruptcy of the city
and it was not certain whether he wanted to involve himself in a project so tightly connected to his political
enemy.
Despite these external pressures, and the fact that Aguas de Barcelona was the only company to
submit a bid, the city felt that its negotiations were going well. Also, Aguas de Barcelona specialized in
water and sewerage management and could offer the technical assistance critical to improving the city’s
systems. Since this was Cartagena’s main concern, negotiations progressed quickly. On December 29, 1994,
after three months of deliberations, the ‘bid’ was awarded to Aguas de Barcelona. On December 30, 1994,
the penultimate day of Mr. Garcia’s mayoral term, Aguas de Cartagena (Acuacar) was incorporated as the
mixed capital company responsible for managing and operating Cartagena’s water and sewerage system.
Aguas de Cartagena (Acuacar)
Acuacar had the following structure and attributes:

• The company was governed by the shareholders, of which there were three categories: 1) the
private operator- Aguas de Barcelona, 2) the city of Cartagena and 3) other private investors.
The shareholders owned 100 percent of the stock of the company, which at the time of
incorporation was equal to Acuacar’s total asset value, $4.0 million. 15 Each shareholder paid
the portion of $4.0 million equal to its stockholdings. For example, Aguas de Barcelona would
own 86 percent of the stock and pay $3,440,000.
• The Cartagena City Council was no longer responsible for appointing the board of directors.
Acuacar’s major policy decisions were entrusted to a five-member board, three of whom were
appointed by the private operator, one was appointed by the Mayor of Cartagena, and one of
whom was the Mayor himself.
• The hiring of personnel and all other day to day decision making were entrusted to the General
Manager, who was appointed by Aguas de Barcelona. The Board of Directors, however,
approved the annual budget and the company’s financial statements.
The water and sewerage services were managed by the private operator, Aguas de Barcelona, via
its influence as a shareholder in the company, its power to appoint three of the five members of Acuacar’s
board of directors, and its power to appoint the General Manager.
This influence was considered necessary in order for the private operator to integrate its technical
expertise and management experience into the city’s systems, thereby improving service to residents.
14 This opposition was especially acute given that the private operator would be a Spanish firm. This prejudice
spawned from Cartagena’s proudly held history as one of the first towns to proclaim independence from Spain.
Hence, the phrase ‘Spanish control’, when made in reference to the management of the city’s water system,
brought out significant opposition from residents.
15 This amount was low because Acuacar, as an operating company, held few assets.
7
However, given the lack of federal regulatory enforcement over natural monopolies in Colombia, 16 it was
equally important that the city be able to monitor the actions of the private operator. This ‘supervision’
would ensure that the private operator’s actions were in concert with the priorities of the city. Although
several agencies were in place on a federal level- such as the Regulatory Commission of Potable Water and
Sanitation and Superintendency of Public Services- these agencies were new, 17 weak in their enforcement
abilities, and horribly overburdened. The institutional structure of the regulatory scheme had created
difficulties in coordination among regulatory agencies, which also hampered enforcement efforts.
Therefore, the contract gave Cartagena the right to appoint a “supervisor” (regulator) to oversee the
implementation of the concession.
Hence, other forms of internal control were essential and were built into Acuacar’s organizational
structure. For example, all board meetings required 80 percent approval for decisions made by the board.
This ensured that the city had veto power regarding major policy decisions. The mayor, as one of the two
board members representing the city, was required to preside over all of Acuacar’s board meetings. This
gave the mayor administrative control over these meetings. Finally, an external auditor was appointed by
the city to verify the company’s accounts.
A critical element of the company structure was the establishment of a Reversion Fund, which
would gradually pay back the private operator for its initial stock purchase. After a grace period of five
years, Acuacar would annually pay to the operator 1/20th of the amount it originally paid for stock, plus
interest, adjusting for inflation and irrespective of profits or losses of the company since the total asset value
of Acuacar was $4 million at the time of incorporation. The annual return payments to Aguas de Barcelona
were equal to five percent of the asset value multiplied by the percentage of stock in Acuacar owned as
Aguas de Barcelona -- a relatively small dollar figure. The purported purpose of the Fund was to remove the
capital finance risk that Aguas de Barcelona was assuming in operating a company partially controlled by a
public agency. There would, however, be no residual loss of control. In addition, Aguas de Barcelona
received an operation “fee” of approximately five percent of the revenue collection. 18
Negotiations with a New Mayor
At the beginning of Mayor Paniza’s term in January of 1995, it seemed as though the company
might never assume operational control of the system. In fact, the new mayor was considering liquidating
Acuacar. “You must understand”, he stated, “I believe that man, my predecessor [Mayor Garcia], should be
in jail. I believe that everything he did as mayor was done to fill his pockets. So when I first looked at the
Acuacar deal, I thought, ‘there has to be some trick here.’ For one, the bid proposal only took three weeks
to prepare, which is very strange. The whole thing to me was suspect.” Before the mayor decided to act on
16 Regulation over the monopolies was the responsibility of the federal government. Water rates were proposed by
the municipal companies and approved or disapproved by the regulators in Bogata.
17 The Superintendency was created under the new political constitution of 1991 and the Regulatory Commission of
Potable Water and Sanitation was formed in 1994 under Law 142. The former supervises the management of
water and sewerage service companies; the latter regulates natural monopolies.
18 The actual fee was linked to Aguas de Barcelona’s success in reducing unaccounted-for-water and improvements
in the collection rate.
8
his misgivings, he visited Mr. Libhaber of the World Bank in Washington, D.C. “Mr. Libhaber told me that
I would be making the biggest mistake of my life, that the World Bank held Aguas de Barcelona in high
regard. And so I decided to review the whole process again myself”.
The review and renegotiation process took six months, during which the Mayor was deliberately
recalcitrant. “I was being difficult,” stated Mr. Paniza, “but I felt it was necessary because I could not, and
did not, assume that my predecessor had properly represented the interests of Cartagena’s residents.” These
renegotiations resulted in only one major change to the original structure of Acuacar.
This change, however, was a shift in shareholder control away from Aguas de Barcelona and
toward the city- and it almost proved a deal breaker. According to the original negotiation, 1)Aguas de
Barcelona would own 86 percent of the stock, 2) the city would own 10 percent, and 3) other private
investors subscribed to 4 percent. 19 Mayor Paniza and his advisors claimed that this division of shares was
contrary to Law 142, which requires that at least 50 percent of a mixed capital company be owned by a
public entity. In order to keep within the letter of the law, therefore, the Mayor’s office claimed that the
shares would have to be divided as follows: 50 percent to the city, 46 percent to the private operator and 4
percent to other private investors. Aside from following the law, Mayor Paniza was also interested in having
the city be the majority shareholder, and increase its ‘supervision’ power over the private operator.
This shift triggered a major conflict between the new mayor and Aguas de Barcelona. Several
meetings broke down without resolution, simply because the discussion was so heated. Even though Mayor
Paniza did not want Aguas de Barcelona to back out of the deal, he remained adamant in his demands. In
the end, Aguas de Barcelona agreed to lower its shareholdings from 86 percent to 46 percent, and become a
minority shareholder. This concession had two important disadvantages for the private operator: 1) their
capital finance risk increased by having a public agency control Acuacar, and 2) they would forgo almost
half of any future profits by receiving dividends on only 46 percent of the shareholdings, as opposed to
receiving dividends from 86 percent of the shares. The new Acuacar Board would consist of two members
appointed by the city, two by Aguas de Barcelona, and one by the private stockholders.
However, because the Reversion Fund would reimburse with interest any amount of money the
private investors paid for stock, the private operator’s capital risk was actually zero whether it owned 86
percent or 46 percent of Acuacar. Furthermore, Aguas de Barcelona would still receive an annual
management fee of 5% of all revenues collected. As to the reductions in forgone future profits, Aguas de
Barcelona decided to be optimistic. “We believed that Aguas de Barcelona would regain a majority
shareholder position in the future, perhaps when the City was represented by a different Mayor,” stated Luis
Albacete, the General Manager of Acuacar, “Furthermore, we knew our efforts as private operator would
eventually increase the trust between Aguas de Barcelona and the city, as well as the value of the stocks of
Acuacar. We believed these two dimensions would eventually encourage the city to sell part of its shares
and use the funds for some other purpose within the city.”
19 Aguas de Barcelona subscribed to 86 percent only after other private investors, who were allowed to subscribe to
up to 39 percent of the stock, purchased only 4 percent. Aguas de Barcelona was then obliged to purchase the
remaining 35 percent, increasing its shareholdings from 51 percent to 86 percent.
9
Once the private shareholders agreed to the new change in shareholding, new bylaws for the
company were adopted and the operations and maintenance contract between the city and Acuacar was
signed on June 12, 1995.
The Operations and Maintenance Contract (O&M contract)
The contract signed between the city and Acuacar was a 26 year O&M contract, in which the
private operator would assume management control of water and sewerage service. Although 26 years was
considered long for an O&M contract, it was generally believed that this amount of time would provide the
private investors a reasonable return on their investment (the company was not expected to turn a profit for
at least five years). It would also allow the private operator and new company sufficient time and resources
to upgrade the network.
The responsibilities of the various parties in the contract included:

Responsibilities of the city
• The city owned the system assets and was responsible for future network expansion.
• The city assumed control of paying all pension premiums of former EPD and EPM employees,
and assumed responsibility for any labor suits or grievances filed thereby.
Responsibilities of Acuacar
• Acuacar was responsible for providing efficient, high quality water and sewerage service to
residents within the city’s network, and for rehabilitating the system into proper working
order.
• Acuacar was responsible for tariff collection and use of tariff revenues.
• Acuacar would use the tariff structure as established by the EPD during the first two years of
operation. 20
Responsibilities of Aguas de Barcelona
• Aguas de Barcelona agreed to transfer technology in order to increase the operational,
administrative and technical efficiency of the company.
• Aguas de Barcelona promised specific and quantified improvements in billing collection and
other operational management indicators.
Some of these responsibilities were significant. First, by having the city assume control of the
municipal companies’ pension premiums, which were consuming 40% of the EPD’s operating revenues,
Acuacar had greater funds available for proper maintenance of the system. Second, Acuacar was
responsible for tariff collection and use of tariff revenues (which are usually controlled by the public entity
in an O&M contract). Third, since the private operator would have to return the water and sewerage system
in proper working order, Aguas de Barcelona had a strong incentive to make the investments needed to
20 It was assumed that this provision would reduce the fear of citizens that private control of the system would
result in large rate increases. After these two years, tariffs would be established by Acuacar and approved by the
Regulatory Commission of Potable Water and Sanitation, the new federal agency established under Law 142.
10
rehabilitate the system. Finally, since the city had gained control of the company, it decided not to exercise
its right under the contract and appoint a supervisor. The Mayor saw himself as the “regulator.”
Two other aspects of the contract, beyond party responsibilities, were important. First, although
Acuacar’s employees could unionize, the company had no obligation to negotiate with the SINTRAEMDES
union because it was not strictly a public entity. This technicality, together with a decline of labor power in
Colombia at that time, essentially shut the union out of the O&M contract negotiating process. Second,
there is little mention in the contract regarding preparing the system to meet the long term future needs of
the city. “This was deliberately left out of the contract,” stated Gloria Yepes, who represented the Mayor’s
office during negotiations, “We were trying to solve a crisis first. We could hardly estimate the current
needs of the city, because the system was in such a state of disarray. We were simply not in a position to
negotiate for the future needs of the city. Unfortunately, it is a blank spot in the contract.”
Although not included in the formal renegotiation process, union workers of the EPD made their
voices heard by threatening to strike, damage the system and disrupt the process. As a result, the Mayor and
his advisers kept the date of transfer of the EPD system to Acuacar confidential- sharing it only with those
individuals indispensable to the change. The unionized workers even threatened that if the city intended to
remove them from their positions during the transfer, it would have to do so, literally, over their dead
bodies. Therefore, the transfer itself was arranged to happen as quickly as possible, and by surprise. Mayor
Paniza recalls, with a certain humor developed from hindsight, “I hardly slept the night before Acuacar took
over operations, given the hostility toward the deal. From the balcony of my apartment, which overlooks a
large part of the city, I imagined columns of smoke rising from various parts of the city as a result of
fighting between the union and the police.”
The transfer occurred on June 26, 1995 without violence, but not without incident. Subsequently,
the union attempted to bring criminal charges against Mayor Paniza. “I was told by the Attorney General
who came to investigate the charges, that the union was accusing me of every crime stated in the law, and
all crimes that might be stated in future laws.” These charges against the Mayor were dismissed after the
investigation made by the Attorney General found them without legal merit. On August 4, 1995, the
Mayor’s office, the EPD (now in liquidation) and its former workers, represented by SINTRAEMDES,
signed a labor agreement, which offered a pension plan for those who met the retirement requirements and a
compensation payment for those who did not. The labor agreement signified, in large part, the end of union
opposition to the management of Cartagena’s water and sewerage system.
Results
Acuacar moved quickly to improve water services. Within six months of operation, a new
computerized commercial and accounting system was established to expedite customer assistance, six
service centers were established, and network maintenance and rehabilitation programs were implemented.
Through improved water production processes and testing, Acuacar also increased water quality by
lowering amounts of organic load, lowering the turbidity level of the water, improving color, and improving
chlorination techniques (see Exhibit III). Acuacar also invested over six million dollars in the first year of
11
operations on repair investments (such as installation of new piping and cleaning of old piping) to
rehabilitate the city’s water and sewerage systems.
In an effort to win over residents’ approval of the company, Acuacar also implemented a large
public relations campaign. The company organized outreach programs in each of the wards of the city,
which included educating community leaders about the water treatment process and the changes Acuacar
were implementing. This outreach not only demonstrated Acuacar’s efforts to improve service, but began to
alter the view, held by most residents, that drinking water was a free and ever-abundant resource. These
efforts began to change the relationship between the company and the community from one of distrust to
one of confidence and coordination. For example, community groups started to work with Acuacar to help
detect illegal water connections.
Significantly, residents of all socio-economic levels of the city experienced the improvement in
water services. Luis Felipe Hereño, a teacher and veteran activist for improving the quality of life of poor
Cartagena residents, concedes his approval of Acuacar. “There was a fair amount of resistance [to Acuacar]
at first,” he stated. “However, although prices have risen slightly, we see the improvements in service to
poor residents, and an expansion of the network, even in low income neighborhoods. This is a big
improvement over the public entity, which was politically driven and poorly managed”.
Acuacar accomplished the following within the first year and a half of operations:
• Increased consumers with water meters from 45,000 to 70,000.
• Increased bill collection rate from 45 percent (under the EPD) to 85 percent.
• Increased detection of illegal connections, from 321 in 1995 to 2166 in 1996.
• The company made a profit of $900,000 in the first year of operation, versus an annual deficit
of $2.5 million under the EPD. 21
In addition, the relationship between employees and management, for the most part, normalized.
On December 6, 1996, a three year Collective Agreement was signed between the company and the new, in-
house union. Employee working conditions improved as a result of increased worker safety investments and
employee training. In 1996, for example, Acuacar invested $120,000 in employee training, which paid for
29,517 hours of instruction to workers. The human resources department noted that that sick days and
accidents were significantly reduced after privatization.
The Next Step
The results seemed unanimous: Acuacar was a success. “Of all that has happened during my term
as mayor, I am most pleased with the results of the Acuacar privatization effort,” stated Mayor Paniza. “Ask
anyone on the street if they would return to the old system, and they will tell you absolutely not,” stated
Luiz Pinzon, the Financial Coordinator of Acuacar.
21 It should be kept in mind that transferring the payment of pension obligations from Acuacar to the city played a
major role in explaining the company’s positive financial results.
12
Despite all of the good news, there were still serious issues facing the company as of June of 1997.
The most pressing of which was finding the capital needed to expand the network. Around 25% 22 of
Cartagena’s population remained without water service, and water rationing was still a reality for 42 percent
of the city’s residents. In addition, treatment plants for the city’s sewage would have to be built and the
sewage collection network would have to be redesigned so that the effluents would be collected at the
plants. Finally, the capacity of the sewerage system would have to be expanded to nearly double its capacity
in order to manage all of Cartagena’s waste.
The city, which retained responsibility for system expansion under contract, would normally raise
funds for enlarging the system through taxes, grants from the national government, or loans from the
government or international lending institutions. Because of Cartagena’s financial problems, however, the
city’s ability to obtain such funding was limited and planned capital investments were often delayed. As a
result, the city allowed Acuacar to invest in improving the system. The city also ceded control of the plan
for network expansion to Acuacar because it lacked the resources to properly design and administer it. In
September of 1996, for example, Cartagena transferred control of the Master Plan process to Acuacar
providing the company with the right to insure that all expansion projects were compatible with the master
plan. For example, if the city decided to fund an expansion project to be delivered by an entity other that
Acuacar--Acuacar could veto it as incompatible. The only recourse available to the city was for the Mayor
to veto the entire Master Plan.
Aguas de Barcelona agreed to let the mixed capital company assume these responsibilities, since it
gave them more autonomy in the system’s investment decision making process. Instead of being told which
investments to make, the private operator could devise its own investment plans for the system. Of course,
such investments would still be under the supervision of the city (the mayor and his representative could
veto the investment plans at a board meeting). However, given the city’s lack of expertise in managing
water and sewerage systems, the capability of the city to fulfill this responsibility was questionable. The
private operator had the ability to plan investments that would better maximize its profits without
necessarily maximizing the well being of Cartagena’s residents.
As of June of 1997, another plan was being developed which would require the city to relinquish
more control over Acuacar for purposes of network expansion. Officials at Acuacar were deliberating over
whether to recapitalize the company stock and allow the International Finance Corporation (IFC) to join as
a new shareholder. If the IFC became a shareholder of Acuacar, it would agree to lend $60 million (1997
dollars) to the mix capital company to pay for expansion of the water system. This loan would be repaid
from Acuacar’s revenues and not city funds. Although this option would pay for a significant portion of the
needed network expansion without increasing the city debt, it would reduce the city’s control over the
private operator because the IFC loan required that 51% of the mixed capital company stock be privately
owned. Choosing to lose its position as majority shareholder would have to be carefully considered by the
city given the power it had already ceded to Acuacar and given the limited regulatory control over natural
monopolies in Colombia.
22 The percentage of residents without service reduced from 30 percent before privatization to 25 percent after from
network repair of the system.
13
On the other hand, if the city refused to recapitalize Acuacar, it would place itself in greater debt
and the expansion of the water system would likely be delayed. Slow expansion of the infrastructure carried
its own risk for the city. Given the improvements residents experienced in water service in the first few
years of Acuacar’s operations, residents would expect continued improvements to justify the proposed rate
increases. The combination of delayed system improvements and increased rates could cause a backlash
against the company and the city. With these financing and system control challenges in the balance, the
city would be at a crossroads regarding the option to recapitalize. The new mayor entering in January of
1998, would have to weigh the options carefully.
14
Exhibit 1
Timeline of Important Events Prior to
and During the Privatization Process
Cartagena, Colombia
15
Exhibit II
Map of Cartagena, Colombia
16
Exhibit III
Financial, Operating and Water Quality Indicators
Before and After Private Sector Participation (PSP)
Cartagena, Colombia
Financial Indicators
Before PSP After PSP
Indicator (as of June, 1995) (as of December, 1995)
Operating Revenues
(millions of dollars) 10 12
Gross income (annualized)
(millions of dollars) -2.5 0.9
Operating Indicators
After PSP
Before PSP (as of August 1996 unless
Indicator (as of June, 1995) otherwise indicated)
Percentage of population with water service
Percentage of customers experiencing severe 70 N/A
rationing 23
Percentage of customers experiencing mild 20 12 (Dec./1996)
rationing 24
40 30 (Dec./1996)
Percentage of population with sewerage
service 50 N/A
Percent of sewage that is treated before
disposed 0 0
Bill collection rate
(percentage of customers) 43 85
No. of employees 1200 (June/93)
500 (June/95) 400 (July/97)
Unaccounted water (percentage of total
treated water produced) 52 50 (Dec./95)
Percentage of customers metered for water
consumption 47 61 (Jan./96)
No. of customers
• water service 84,000 89,000
• sewerage service 70,000 73,000
Amount of treated water produced 165,000m3/day 205,000m3/day
23 Severe rationing is defined as receiving water service four to six hours a day, four days a week.
24 Mild rationing is defined as receiving water service twelve to eighteen hours a day, seven days a week.
17
Exhibit III (Cont.)
Water Quality Indicators

Before PSP After PSP
Indicator (as of June, 1995) (as of August, 1996)
Water testing (no. of tests/month)
• physical-chemical 22 440
• bacteriological 220 440
• residual chlorine 220 550
Turbidity (in UNF) 2.0-2.5 0.5-1.0
Color (Color Units) 10-13 5
Organic load 2.5-4.0 mg/L (102) 0.9-1.5 mg/L (102)
18

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Kennedy School of Government HKS415

Case Program CR15-99-1482.0

Origins Of The Problem

Administrative and Operational Problems

Attempted Reform of the EPM

The Liquidation of the EPD

Regulatory Foundations of the Privatization Effort

Aguas de Cartagena (Acuacar)

Acuacar had the following structure and attributes:

Negotiations with a New Mayor

The Operations and Maintenance Contract (O&M contract)

The responsibilities of the various parties in the contract included:

The Next Step

Exhibit III (Cont.)

Water Quality Indicators

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