Lessons From the Department of Defense Utility Privatization … · 2017-10-12 · underway. Likewise, the US Air Force has placed a “strategic pause” on the program to evaluate

84 SEPTEMBER 2016 | JOURNAL AWWA • 108 :9 | SORENSON & RETZLAFF

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Unlike the way many utilities view privatization, the Department of Defense (DoD) began privatizing (selling) utility systems in 1998, presenting an acquisition potential for local utility pro-viders. However, the DoD has had varying success with the program and sometimes receives only lukewarm, if any, interest

from local utility providers—perhaps because of its unique approach. Acquir-ing a DoD utility system and the associated utility privatization service con-tract certainly presents challenges, but also tremendous opportunities. This article highlights the history of the DoD privatization program, discusses upcoming water/wastewater systems scheduled to be privatized, and covers factors that utility providers should consider when pondering acquisition of a nearby DoD utility system. These factors include contractual concerns, acceptance/transfer of risk, pricing, competition from other utility providers, political sensitivities, off-military-base rate-payer impacts, value to the com-munity, regulatory matters, and the cost and complexity of proposing. The article also discusses two successful utility privatization examples (water and wastewater) at Naval Air Station in Key West, Fla.

A DEPARTMENT OF DEFENSE

PROGRAM OFFERS LOCAL

UTILITY PROVIDERS THE

OPPORTUNITY TO PROVIDE

MILITARY INSTALLATIONS A

LONG-TERM SOLUTION FOR

SUSTAINING IMPORTANT

INFRASTRUCTURE SYSTEMS

AND THE SERVICES THOSE

SYSTEMS PROVIDE FOR

MILITARY BASE PERSONNEL

AND OPERATIONS.

sources and supply

JEFFREY S. SORENSON AND SONDRA RETZLAFF

Lessons From the Department of Defense Utility Privatization Program

sources and supply

SORENSON & RETZLAFF | 108 :9 • JOURNAL AWWA | SEPTEMBER 2016 85


A POSSIBLE WAY FORWARDProgram history. The DoD utility

privatization program is rooted in the challenge of balancing the need to repair aging military installation infrastructure with federal funding limitations and competing demands. The current condition of existing utilities on military installations clearly demonstrates the need for investment, but presents tough choices for commanders at the installation and higher levels. Despite their direct support of the mission and the way they enhance quality of life, utility systems always compete with and frequently lose to other investment priorities, something municipal utilities also experience. Often, underfunded accounts desig-nated for infrastructure improve-ments are the result of investments in important weapons-system upgrades. When adding that utility systems typically are not readily vis-ible, those underfunded accounts are normally directed to highly visible military base facilities because of the perception that visibility implies importance.

To tackle this problem, the DoD looked for ways to gain the best value and efficiency to maintain mis-sion readiness while also improving neglected infrastructure. Aside from a few exceptions, utility ownership and even system operation and maintenance are not essential skills for wartime missions, which has given Congress the flexibility to establish privatization as a new means of financing these projects.

The National Defense Authorization Act of fiscal year 1998 authorized the DoD to transfer ownership of its utility systems and added legislative authority under 10 USC 2688 (US Government Publishing Office 2012). Soon after, Defense Reform Initiative Directive #9 in December 1997 directed military depart-ments to privatize electric, gas, water, and wastewater systems. At the outset, the DoD owned 2,600 utility systems valued at $50 billion. Exemption under 10 USC 2688 is

allowed if privatizing a system proves to be uneconomical or pres-ents a security risk; however, since the legislation was passed, several systems exempted for economic reasons early in the process are being reissued for another attempt to be privatized.

Program overview. When on-base utility systems are privatized, they are sold to private or public entities—specifically, those that exist to oper-ate and maintain utility systems, such as municipal- or investor-owned utilities. In this way, the pur-chasing entity becomes responsible for operations, maintenance, and improvement of the military base systems. The military installation becomes the customer or user and enters into a service contract that often has an initial term of 50 years. The contract generally contains a rate structure that leads to greater predictability of costs (tariff-based or fixed-price with economic price adjustments). Under the contract, the government retains ownership of the land around the utility with access provided by means of a right-of-way or easement. Because of the com-plexities in the procurement process the DoD uses to issue the requests for proposal (RFPs) for each utility ready for privatizing, the initial goals of privatizing by Jan. 1, 2000, proved unsuccessful, as did further attempts with new deadlines.

Privatization process. When initiat-ing a privatization action, the govern-ment’s first step is a “sources sought” query to gauge the level of interest among qualified entities. If there is enough interest (usually at least two qualified parties), an RFP is issued for each utility being privatized,

typically 3–6 months later. Energy utilities (gas and electric) are nor-mally in a separate RFP from water and wastewater as a means to match the interests of most utilities. The proposing entity can then choose to propose on just one or both systems in the RFP. These intensive RFPs

(300-or-so pages) require the inter-ested utilities to sort through and digest an enormous amount of tech-nical data and utility system details to use as the basis for their pro-posal. The proposal covers both the acqu i s i t ion /purchase o f the system(s) and the 50-year opera-tions, so pricing is a critical element. However, as a best-value procure-ment, price is less important than the combined factors of technical capability (e.g., operations and maintenance plan, emergency response plan, renewal and replace-ment plan), past performance (e.g., customer satisfaction, utility history, regulatory compliance), risk to the government, and socioeconomic support (support to and use of small businesses). Four to six months is normally allowed to develop and submit the four-volume proposal; for the level of effort required, this is not an excessive schedule.

Although price is not the most important evaluation factor, it is nonetheless important to both the government and the proposing utility. The price offered for a utility privati-zation is made up of three main com-ponents, as illustrated in Figure 1: the utility service charge, initial system deficiencies correction and connec-tion charges, and transition charges.

The utility service charge is nor-mally l imited to one of two options—either as a regulated tariff

Acquiring a DoD utility system and the associated

utility privatization service contract certainly

presents challenges, but also tremendous

opportunities.



subject to a statewide regulatory authority or as an annually adjust-able fixed price to a known index such as the consumer price index. The charge includes operations and maintenance costs, ongoing renewal and replacements cost, the credit to the government for the fair market

value purchase price, and the recov-erable portion of the purchase price (not to exceed 100%).

The initial system deficiencies cor-rections charge covers the short-term costs to correct the deficiencies iden-tified in the RFP. The costs are recov-ered from the government via monthly payments and may include recovery of interest if work was financed by the new owner.

The transition charge covers the new owner’s efforts to take over responsibilities, including permit transfers, staffing, and meetings with the government. The duration of the transition period is proposed by the utility.

Following submission of the pro-posal, the government’s selection pro-cess for the best-value offeror for each system is complicated. Each

system must be evaluated separately (which is often the reason for a util-ity to submit a separate proposal for each system) to prove the economic standard set by 10 USC 2688 (US Government Publishing Office 2012) . During the initial evaluation of all proposals, the government will

develop questions for proposers that are determined to be technically qualified for the privatization. Those proposers will receive questions from the government between six and 12 months after proposals were submitted. This begins the formal process known as “discussions.” Although the government always reserves the right to award a con-tract without these discussions, it is rare with a process as complex as privatization. During discussions, the government may go through several rounds of questions with the propos-ers and may ask for revisions to pro-posals that reflect the answers pro-vided to questions. Discussions terminate with the government’s request for “final proposal revi-sions,” which reflect the utility’s best and final offer.

The government will next deter-mine the proposer that represents the apparent best-value offeror for the government. This offeror will enter into negotiations with the government to finalize terms and conditions of the contract, perhaps conduct some addi-tional due diligence on the utility system(s) being privatized, and make preparations to execute transition and startup. The government, meanwhile, has a lengthy approval process to go through for final authority to divest the utility system(s) and execute the 50-year contract.

Program outcomes. Today, the office of the Deputy Undersecretary of Defense reports that military departments continue making prog-ress with privatization without spec-ifying goals for completing the pro-gram. In recent years, the US Navy has made little or no evident prog-ress to privatize new systems, but evaluations of the value of privatiza-tion and actual savings realized are underway. Likewise, the US Air Force has placed a “strategic pause” on the program to evaluate the ben-efits, but continues to execute the advertised schedule—at least up until final award of a contract. Last year, the Air Force reported that 167 of about 660 utilities systems were privatized, avoiding more than $500 million in costs. Of the 660 systems, 160 were exempted as noneconomic and 122 systems are in various stages of contracting.

CHALLENGES AND OPPORTUNITIES

Demanding process. Interested enti-ties can find the process lengthy and labor-intensive. A large investment of time, effort, and money is going to be necessary not only to complete the initial proposal, but also to tra-verse the lengthy discussions and negotiations process. In addition to a local utility possibly having little or no experience with federal contracts, the complex RFP (300–400 pages, plus technical data) often leads to noncompliant proposals or may be so intimidating that it discourages

FIGURE 1 Primary components of the price offered for utility privatization

Utility servicecharge

ISDCs/connectioncharges

Regulated tariff

Transitioncharges

Fixed-price economic price adjustment

Total cost

ISDC—initial system deficiencies corrections

Energy utilities (gas and electric) are normally in a

separate RFP from water and wastewater as a

means to match the interests of most utilities.



submitting a proposal at all. In the event the proposal process moves forward, the board or council approval that is often necessary to proceed can be hindered by a lack of awareness regarding benefits. Federal Acquisition Regulations and contract clauses can cause fear of risks that must be mitigated. For example, termination-for-convenience clauses appear one-sided and risky, but can actually be very fair. Nonetheless, other issues such as potential impacts on existing ratepayers must be assessed and resolved.

Future regulatory changes or those caused by the government (including military base closure), and decreas-ing or even increasing system requirements, may also appear to be a risk to the new owner. However, provisions are available to negotiate such changes with the government and recover costs required to accom-modate these changes.

Further challenges to the process relate to DoD staff turnover and approvals. US government contract-ing officers have experienced high turnover, depleting knowledge of the privatization process and con-tract execution experience. Neces-sary approvals from government agencies are burdened by multiple layers in the chain of command. The process, which ideally should take less than two years, often requires three years or more.

Finally, each military base or post that privatizes systems is unique in its location and challenges. For example, various system deficiencies may require early investment by the new owner, or technical data may be inaccurate or called into question. In some cases, such technical data may be scarce or even unavailable.

Potential benefits to the government. Despite the demands of the process, privatization can offer benefits to both the DoD and the prospective new owner. The warfighting mission is paramount to the government, but the health and welfare of military and civilian personnel and families is still a significant need. Privatizing its

utilities relieves the government of the daily responsibility for assets that support the warfighting mission but are not inherently government func-tions and therefore don’t have to be owned and operated by the military. This may raise the question about

trained staff for overseas wartime or contingency situations, but training is something that can easily be provided by the new owner as a contractual requirement. Deployable Air Force civil engineer personnel, for example, often require this training.

Privatization also delivers im -proved utility services that are more reliable and comply with industry standards. Financially, previously unfunded requirements that switch to a “must-pay” utility bill, which is an immediate expense, reduce long-term costs to the installation. This can be especially true when the pub-lic utility’s tax-exempt status trans-lates to low-cost financing, thereby providing a better or best price to the government.

Potential benefits to the local com-munity. If a local public utility exists near a military installation, signifi-cant social and economic benefits can be realized for the community. In this situation, the local utility knows local conditions and the unique challenges of the area. It is common that the prospective owner already provides the commodity (such as water, gas, or electricity) to the military-base fence line or is already treating the wastewater. In addition, the public utility’s status as a nonprofit entity gives it access to low-cost financing and may pro-vide the best price to the govern-ment . The mi l i tary and the

community can share the costs of resources such as expensive equip-ment, and the public utility can build an increasing customer base for greater revenue. The purchase of the installation utility stimulates the local economy and reinforces

the connection between the com-munity and the military installa-tion, potentially even reducing the vulnerability of the installation to future base closure. Finally, and in spite of recent examples of com-munities having financial struggles or even battling bankruptcy, the public utility is more likely to remain solvent and wholly intact during the 50-year contract.

FACTORS TO CONSIDERA public utility considering priva-

tizing one or more utility systems at a local military installation has many factors to consider; following are a few that have been encountered.

Contractual concerns. The previ-ously mentioned Federal Acquisition Regulations clauses and contract language place limits on the new owner’s use of the systems and define owner rights for changed conditions and recovering costs for new require-ments. These may be onerous but generally not unfair.

Commodity contracts. If the local utility is selling the water commodity to the military installation and/or treating its wastewater, the govern-ment’s intention is that these existing contracts remain intact and separate from privatization. However, per-haps there are advantages to either the government or the utility (or both) to combine contracts. These should be considered.

Aside from a few exceptions, utility ownership and

even system operation and maintenance are not

essential skills for wartime missions, which has

given Congress the flexibility to establish privatization

as a new means of financing these projects.



Acceptance/transfer of risk. The government will transfer all permits and responsibilities for the systems, but retains liability for preexisting environmental contamination. The new owner’s risks include bringing

the systems up to standards, but the government pays for those projects.

Pricing. Only a state-regulated util-ity can use a tariff for the utility ser-vice charge; therefore, all others must build up the cost basis for a fixed annual price with economic ( indexed) price adjustments. Although fair market value must be “paid” by the utility, it can be fully recovered if the new owner has no other potential customers to serve with the privatized systems.

Competition from other utility pro-viders. Larger systems, especially those with on-base treatment, will attract the attention of larger inves-tor-owned utilities and other private entities, some with significant military privatization experience. Competing with them requires expertise in the process and a thorough response to every item in the government RFP. An investor-owned utility or other entity taking over the military system inside the municipal service area could be perceived as a threat to current utility operations and city staff.

Political sensitivit ies. Local municipal politics play a role in nearly every key decision such as whether to pursue the privatization of military utilities. Early engage-ment, even before the RFP is released; and some assessment of the potential risks, costs, revenues, the pros and cons; and perhaps even what is known as a SWOT

(strengths-weaknesses-opportunities-threats) analysis, will help prepare the mayor, council, or board to make the right decisions.

Off-base ratepayer impacts. There often is the potential that a new utility

service contract will have some effect on the other local ratepayers. Ideally, this is an opportunity to spread existing fixed costs and decrease that effect, but with a 50-year fixed-price with economic price adjustments contract, the reverse could be the case. That is not the government’s intention, so this situation should be considered.

Value to the community. It is likely that the local community is support-ive of the military installation. How important is it to strengthen those ties? What would the community do if the installation were closed or sub-ject to significant downsizing? What can the community offer as benefits through a privatization proposal?

Regulatory matters. The local utility likely has positive relationships with the regulatory agencies but must consider the impacts of taking on the installation systems. Will there be noncompliance issues to deal with? Are regulatory changes imminent that the installation systems will not meet? Will permit transfers be easy or cumbersome?

Cost and complexity of proposing. The local utility must consider the cost of developing the four-volume proposal (the current Defense Logis-tics Agency model) requiring exten-sive technical discussion of opera-tions and maintenance practices, demonstration of experience in own-ing and operating similar systems,

experience with acquiring or taking over responsibility for new systems, and detailed pricing forecasts cover-ing the 50-year contract period. It is essential that the proposal be com-pleted thoroughly and accurately to be successful in the process. In dis-cussions with government officials, the greatest weakness in proposals submitted by local utilities has been the failure to clearly answer the requirements of the RFP.

Most of these factors can be dealt with effectively by using an expert in the utility privatization program. Such an expert can develop risk pro-files and mitigations, system assess-ments, and funding profiles as well as help develop the detailed proposal documents. Table 1 lists the near-term DoD privatization opportunities.

WHAT A DoD PRIVATIZATION PROCESS LOOKS LIKE

Naval Air Station (NAS) Key West, Fla. The Florida Keys Aqueduct Authority (FKAA) is a utility privatization success story. Established by state legislation in 1937, FKAA is the only water utility servicing the Florida Keys. FKAA pres-ently serves nearly 50,000 customers, adding wastewater services in 1998. As the sole provider of potable water for all Florida Keys (Monroe County) residents, FKAA transports the potable water from its well field on the main-land of Florida through a 130-mi transmission pipeline originally built by the Navy, with an additional 690 mi of distribution pipelines. It has been supplying water to NAS Key West since it began service. FKAA has also been tasked by Monroe County with responsibility for all wastewater sys-tems and has constructed several regional treatment plants to begin eliminating the multitudes of existing septic systems throughout the Keys.

In December 2002, the Naval Facilities Engineering Command issued a water RFP with proposals due in June 2003. The RFP included the distribution systems for all Navy prop-erties in Key West. Compared with the current Defense Logistics Agency model requiring a four-volume

In discussions with government officials, the

greatest weakness in proposals submitted by local

utilities has been the failure to clearly answer the

requirements of the RFP.



proposal (one each for technical, past performance, contract documentation, and price), the Key West privatization required a two-volume proposal (tech-nical and price). However, the contents and selection criteria were similar: technical capability, past performance, risk, socioeconomic (small business commitment), and price. FKAA needed help with the proposal; beginning in 2002, the first author of the present article provided assistance with the ini-tial proposal and the government-required revised proposals, continuing through negotiations and startup. Following selection and contract nego-tiations, FKAA was awarded the con-tract in January 2008.

Similarly, in March 2008, Naval Facilities Engineering Command issued an RFP that included the NAS Key West wastewater systems; FKAA sub-mitted its proposal in June 2008. After several revised proposals and some starts and stops resulting from Florida regulatory issues and best options for the government, FKAA was selected as the best-value offeror in March 2015. Following final due diligence and negotiations, the contract was awarded to FKAA in October 2015.

The ownership transfer of these sys-tems has proved beneficial for both FKAA and the government. FKAA folded operations into its existing pro-cesses, saving on costs and time through part-time, as-needed staff on the NAS, which meant only part-time equipment use as well. FKAA invested

immediately to improve system pres-sures and eliminate an old water stor-age tank that posed a potential threat of collapse during hurricanes and replaced more than $3 million in water system components in the first five

years. FKAA has likewise initiated design and construction to connect the NAS wastewater systems to the closest regional treatment plant and demolish the antiquated Navy plant. FKAA and the base personnel enjoy an excellent working relationship. Figure 2 shows the FKAA system in relation to and in support of the NAS Key West facilities.

One of the greatest challenges for both FKAA and the government has been the rate structure used (prospec-tive price redetermination) in the water contract. It has proved to be an admin-istrative burden and time-consuming. Fortunately, that pricing methodology is no longer used in new RFPs; the wastewater contract uses FKAA’s wastewater tariff. To ease the adminis-trative burden on the water contract, the lead author is working with the

Navy to convert the pricing to FKAA’s existing water tariff.

SUMMARYIn response to the challenge of util-

ity systems on federal installations

that competed for mission-support funding, the DoD began privatizing utility systems in 1998. Although optimistic about the potential to make better use of government resources at the same time as achiev-ing updates and longevity for the most basic of utility needs, the DoD has experienced a mixed response from local utility providers. This article has explored the history of the program and what the privatiza-tion process entails. The successful water and wastewater utility priva-tizations illustrated in the NAS Key West case study demonstrate that the potential for value to both the govern-ment and municipality exists. To deter-mine whether it is right for a local util-ity provider, it is important to weigh the pros and cons before committing

TABLE 1 Possible DoD Privatization Opportunities 2016 Through 2018a

Fiscal Year 2016 Fiscal Year 2017 Fiscal Year 2018

Barksdale AFB, La.

Robins AFB, Ga.

Schriever AFB, Colo.

Patrick AFB/Cape Canaveral, Fla.

Oahu/Schofield Barracks, Hawaii

Fort Leonard Wood, Mo.

Anniston Army Depot, Ala.

Aberdeen Proving Ground, Md.

Fort Buchanan, Puerto Rico

Beale AFB, Calif.

Edwards AFB, Calif.

Offutt AFB, Neb.

Yuma Proving Grounds, Ariz.

JB Myer/McNair and Arlington National Cemetery, Va.

Redstone Arsenal, Ala.

Watervliet Arsenal, N.Y.

Rock Island Arsenal, Ill.

White Sands Missile Range, N.M.

Tobyhanna Army Depot, Pa.

AFB—Air Force Base, DoD—Department of Defense

aThis information is current as of Mar. 1, 2016. The listed opportunities are subject to change as the DoD issues solicitations on an ongoing basis.

To determine whether privatization is right for a

local utility provider, it is important to weigh the pros

and cons before committing to the process and to

be prepared to use an expert.



to the process and to be prepared to use an expert in the utility privatization program to deal most effectively with the complexities involved.

DISCLAIMERThe views expressed in this article

are solely those of the authors and do not necessarily represent the views of the Department of Defense.

ABOUT THE AUTHORSJeffrey S. Sorenson is the vice-president of federal programs for Mead & Hunt, 2440 Deming Way, Middleton,

WI 53562 USA; [email protected]. He has worked for more than 15 years with the

Department of Defense Utility Privatization Program assisting public and private utilities in pursuing and winning contracts. Previously Sorenson led the utility privatization program for a private company, running water and wastewater systems for two major Army installations with utility privatization contracts worth more than $1 billion. He earned his master of science degree from the University of Texas, Austin, and his bachelor of science degree from California Polytechnic State University, San Luis Obispo, Calif. Sondra Retzlaff is a corporate communications and technical writer for Mead & Hunt.

http://dx.doi.org/10.5942/jawwa.2016.108.0145

REFERENCEUS Government Publishing Office, 2012. United

States Code, 2006 Edition, Supplement 5, Title 10 - ARMED FORCES. www.gpo.gov/fdsys/granule/USCODE-2011-title10/USCODE-2011-title10-subtitleA-partIV-chap159-sec2688 (accessed Jan. 5, 2016).

SUGGESTED READINGPrivatization of the Water and Wastewater

Utility Systems at Fort Leonard Wood, Missouri. www.fbo.gov/spg/DLA/J3/DESC/SPE600-16-R-0808/listing.html (accessed June 24, 2016).

Privatization of the Water and Wastewater Utility Systems at U.S. Army Garrison West Point, NY. www.fbo.gov/spg/DLA/J3/DESC/SPE600-15-R-0810/listing.html(accessed June 24, 2016).

FIGURE 2 FKAA system supporting NAS Key West, Fla., facilities

Illustration credit: Kyle Pankow, Mead & Hunt

FKAA—Florida Keys Aqueduct Authority, NAS—Naval Air Station, RO—reverse osmosis, Trans.—transmission, WWTP—wastewater treatment plant

Journal AWWA welcomescomments and feedbackat [email protected].

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Lessons From the Department of Defense Utility Privatization … · 2017-10-12 · underway. Likewise, the US Air Force has placed a “strategic pause” on the program to evaluate