A Thirst for Growth

By James Graff / Paris

Ah, the hidden glories of Paris. On the Oise River northwest of the city, the SEDIF water-purification plant uses a nanofiltration system that forces water through 84 acres of membranes housed in a giant matrix of 190 metal tubes. South of the capital in Valenton, one can breathe the swampy odors of a massive wastewater plant that treats 159 million gal. of sewage every day and converts the solid waste into 82,000 tons of combustible pellets--enough to provide 80% of the sewage plant's annual energy needs. And there's that old favorite, les egouts de Paris, the city's sewer and water system dating to the 14th century, a stop for tourists. Granted, the group of American mayors and water experts who recently took in the infrastructure sights didn't pose for pictures. But anyone seeking a fitting image of Gallic irony could hardly do better than the water business in France.

France is the land of public service par excellence, where a whiff of sacrilege still adheres to the very notion of privatizing basic infrastructure. Trains, hospitals, universities and pensions are all largely state provisions. But water--a sector that remains a function of municipal government in 90% of U.S. cities--is the almost exclusive domain of two companies, Suez Environment and Veolia Water.

The business of slaking the world's growing thirst is lucrative, controversial and surprisingly French. Veolia is the world's biggest player in the management of water services. Last year sales rose 10.4%, to $13.2 billion, and earnings 16.7%, to $1.5 billion. Suez drew more than half its 2006 sales of $14.9 billion from the water business, making it the sector's No. 2 in the world.

Veolia in particular is focusing on global expansion. "Ten years ago we did 85% of our business in France. Now it's 45%," says Antoine Frerot, Veolia's CEO. For his company, moving out means moving up: in another 10 years, Frerot figures that Veolia's annual growth in the mature market of France will be 3%, as opposed to 15% or 20% in North America and China.

Suez boss Jean-Louis Chaussade says his company is pursuing "organic growth" everywhere, including through its U.S. subsidiary, New Jersey--based United Water, which has contracts for 7 million people throughout 19 states. "For me, an organic growth of between 5% and 6%--a good three or four points above general growth rate--is the best possible kind of growth," says Chaussade. "Keeping that balance is what made us grow in France and what will make us grow in the U.S. and elsewhere."

Whatever their strategic differences, both Suez and Veolia turn water into cash in the same basic way: securing long-term concessions from public authorities to run, maintain and, if necessary, build water and sewage systems, but not buy them. Both reject the notion that they are privatizing water. "We're delegated providers of a public service," insists Frerot. The idea is to stay "asset light" and profitable while running publicly owned facilities. "In France we've developed over many years a kind of partnership between public and private that works well in the water sector," says Chaussade. "It's an equilibrium between public responsibility and private know-how."

Water is a monumental opportunity. JPMorgan estimated the world municipal water and wastewater business in 2005 at $465 billion a year; by 2015, it figures, it will have almost tripled to $1.2 trillion. Some 40% of the world's population does not have adequate water and sewer systems, according to the U.N. And it's not just the developing world that needs to ramp up investment. The U.S. will have to spend as much as $41 billion a year until 2019 to maintain its water infrastructure, according to one Congressional Budget Office study--that's almost twice the $21.6 billion invested in 1999. "We've got thick pipes from the 19th century becoming obsolete at the same time as thinner ones laid after World War II," says Peter Cook, executive director of the National Association of Water Companies. "If we don't invest more, we're going to face a real crisis."

Suez and Veolia work on the principle that as private companies with broad expertise, they can channel that investment more efficiently than municipal waterworks can. And since it's not they but the owners of the pipes that pony up the money for investment (usually by issuing municipal bonds), these companies can be more financially agile than conventional utilities.

In May 2002 Veolia's U.S. subsidiary beat out Suez-owned United Water for a $1.5 billion 20-year contract to manage water distribution in Indianapolis, the largest such current contract in the U.S.; United Water already had the contract to run the city's wastewater system. The city had purchased the waterworks from a private owner that was struggling, says Tim Hewitt, president and CEO of Veolia Water Indianapolis. "When we started, there were taste and odor problems, and the previous owner had basically told people to get over it." Veolia couldn't do that since the agreement sets incentives for customer satisfaction--along with everything else from water quality to sourcing from local and minority-owned enterprises. Veolia's experts, bolstered by local university researchers, pinpointed the problem as stemming from algae blooms in the reservoirs. Precise application of liquid copper sulfate (yum!) took care of that. "When we took over, there were 500 or 600 complaints a year about taste and odor. Now we're down in the range of 30," says Hewitt.

It's hardly been a picnic though. In January 2005 Veolia issued a boil-water advisory after allowing some subpar water into the system, and came under fierce local criticism for playing fast and loose with public safety. Hewitt insists that the water quality always met EPA standards and that the incident could as easily have happened in a municipally run facility. "We went into this deal with our eyes open, knowing we'd have better and worse years. This is a long-term investment. The Europeans are very patient. And we're on target for success over the 20-year period."

By any measure, the Indianapolis deal has been considerably more harmonious than a 20-year management contract forged in 1998 between Atlanta, under now jailed mayor Bill Campbell, and Suez subsidiary United Water. That arrangement descended into a cacophony of charges and countercharges until it was mutually dissolved in 2003. Its failure may be one reason that the U.S. market, once praised for its explosive potential, has been "a little frustrating," as Hewitt says. But the frustration is relative: Veolia's U.S. business grew 12% last year.

Another problem is national politics. Early last year, Argentina's government terminated a contract with a Suez-led consortium that was providing water services to Buenos Aires. The company also lost its contract to provide water to El Alto and La Paz, Bolivia, after massive protests beginning in 2003 over limited access for poor families. The leader of those protests, Abel Mamani, is the Minister of Water in the government of Evo Morales.

But the water companies have deep pockets, and and they have learned to hold their breath. They've waited out wars and revolutions; a bit of bother in the outre-mer hardly fazes them. Both firms were built around water concessions first granted in the 19th century. The Compagnie Generale des Eaux, which evolved into Veolia, was born in 1853 when the progressive councilors of Emperor Napoleon III granted a group of investors the concession to provide water to the city of Lyon. It was such a hit on the Paris stock market that the company soon spun off its own bank, Societe Generale. Competing bank Credit Lyonnais parried in 1880 with the creation of Lyonnaise des Eaux, which is the core of Suez's water business today. Though the direct links to those banks no longer exist, both companies have been key players in the roiling waters of French business and government ever since.

Suez, of course, built the Suez Canal, but after the seaway was nationalized by Egypt in 1956, the company became largely a financial operator. It was nationalized in turn by the Socialist government of Franc,ois Mitterrand in 1982, a disastrous move that was reversed in 1987, one year before the company got a big piece of Belgium's electricity industry through a merger with the Societe Generale de Belgique. Lyonnaise, for its part, had been shorn of its gas and electricity assets by France's nationalization efforts in 1946. The two merged completely in 1997 and took the common name Suez in 2001.

Veolia's history is no less complicated. After 1994 chairman Jean-Marie Messier moved Compagnie Generale des Eaux full steam into the media business, but his empire cracked after a high-gloss purchase of Seagram to form Vivendi Universal. After Messier's ignominious fall in 2002 in a morass of debt, the environmental-services businesses spun off and dropped the tainted name Vivendi to become Veolia.

And so both companies are alert to historic opportunity--otherwise known as China. The Chinese have awakened to the ongoing train wreck between highly polluted rivers and aquifers and booming cities. "Every year, there are 20 million new urban Chinese," says Frerot. "The authorities have decided to commit as quickly as possible to improving their water and wastewater infrastructures." Veolia has 19 joint ventures in China, and Frerot says the company's short-term prospects there "look better than they do in the U.S." Suez has 21 ventures there after signing a deal to distribute water in Chongqing, China's fourth-largest city, with 32 million inhabitants.

China is just part of the global explosion of demand for water. In absolute terms water isn't any scarcer. The cycle of precipitation and evaporation may be undergoing changes, some of them disturbing-- like the melting of the ice caps and the prospect of significantly higher sea levels. But in per capita terms, water has become scarce. While world population has doubled in the past 50 years, water consumption has tripled. More efficient appliances and toilets have helped push down per capita consumption in the developed world--from 200 L a day 25 years ago to 135 today in France, for instance.

But more frequent droughts, overpopulation and intensified irrigation are pressing water engineers to devise new approaches. And some of them will take some getting used to. Despite a five-year drought widely considered the worst in Australia's recorded history, the residents of Toowoomba in Queensland last year resoundingly rejected an offer from the national government to fund a program to recycle purified sewage water back into the system. Scientific evidence and taste tests couldn't prevail against the yuck factor.

Since then Queensland Premier Peter Beattie declared such recycling mandatory. It's already standard practice in Namibia and Singapore and in cities like London, which draw much of their water from rivers where treated sewage has been dumped upstream. Queasiness is a luxury no one can either afford or justify, since purification technology can handle stuff the coddled minds of suburbia cannot. "Even wastewater is at least 99% water," says Bruce Durham, Veolia's alternative-resources manager. "What matters isn't its history but its quality."

And quality has its price, which is the reason Veolia and Suez can afford to be patient. "Those who advocate free water are wrong," says Suez's Chaussade. "We need to charge for water to avoid waste and deterioration of our natural resources. But this doesn't mean that everyone should pay the same price." The French giants of the industry can shrug and point out that it is not their task to set that price. That's up to markets and governments that want to regulate them to provide access to the poor, subsidize farmers or soak the rich. But Suez and Veolia can take quiet satisfaction from one crystal-clear certainty: over the next 150 years of their business, demand for water isn't going down the drain.