Norhtwest boom masks environmental slowdown

By JOHN R. KANE
Environmental Partners Inc.

The domestic environmental consulting and engineering (C&E) business is currently undergoing significant changes throughout the U.S. in a shift brought on by fundamental market conditions.

There is reduced regulatory enforcement and few new regulatory programs from the federal and state regulatory agencies, and private industry is working with reduced environmental budgets.

An article published in the April 1998 issue of the Environmental Business Journal, discussed the implications of these changes, and in particular, stated that private industry environmental budgets are flat or declining. In fact, the Journal noted that some companies are using non-environmental staff to review environmental budgets.

The Standard & Poor's Environmental & Waste Management Industry Survey dated February, 1998, reported that the U.S environmental industry suffers from weak demand and commodity-like offerings, reflecting mature markets.

Boom or bust?

Does this mean that the U.S. environmental C&E business is experiencing a decline, completing the cycle from a boom or growth market to a mature market, or is this a short-term adjustment?

My view is that the C&E business is experiencing all three of these forces, with the short-term adjustment, within the next two years, resulting in the overall restructuring of the environmental C&E business. Our firm, Environmental Partners, Inc. (EPI), a C&E company with offices in the Pacific Northwest, Southern California and the East Coast, is noticing these trends throughout the domestic U.S. environmental market.

Our southern California office has reported that a large construction remediation firm in southern Calif is laying off many of its environmental professionals and will outsource the work to smaller firms. They won a huge government contract but as a requirement of that contract they must outsource significant portions of the work. We are seeing similar situations on the East Coast, where firms are paring down their environmental staff because there are fewer contracts.

I believe that it is currently difficult to see the ongoing changes, with such a strong economy in the Pacific Northwest and West Coast, but these trends should become apparent when the economy slows or the U.S. economy enters a recessionary period.

Large firm survival

The answer to how firms stay in the C&E business is multi-faceted. On the East Coast, the larger engineering and environmental firms are decreasing their environmental staff, looking lean, but still working with large overheads and low margins.

According to the Environmental Business Journal article, many larger C&E firms have selectively delved into transportation, infrastructure, water, out-sourcing, information technology, process engineering, brownfields redevelopment and other less-regulated service areas.

For example, a large national C&E firm was recently awarded a $22.5 million, seven-year contract by the New York City Department of Environmental Protection to provide design services for the upgrade of the Hunts Point water pollution control plant in New York. There are some niches in which the larger firms will be profitable and will be able to maintain a core staff of environmental professionals.

Effect of larger firms downsizing

Lower employment of environmental professionals by larger firms is introducing many new environmental entrepreneurs into the marketplace who are working alone or starting small niche companies that provide excellent service at less cost to clients. This is great news for the client, providing an opportunity to outsource consulting services to professionals who were doing the same work at the more expensive large C&E companies.

The challenge for these small niche shops will be remaining in business during the next downturn in either the local or national economy. If the small niche operations have a solid core of clients, and provide a service that is needed even during slower economic times, they will most likely succeed.

Mid-range companies

The mid-range firms will grow by consolidating from acquisitions with other mid-range companies. The Environmental Business Journal article noted that an estimated 125 acquisition transactions occurred in 1997 alone. Consolidation will provide more clients for these new firms and movement into the markets currently controlled by larger C&E firms. The mid-range firms will be competing as the lower-cost and highly qualified firm against the larger firms for the less-regulated service areas. This will put additional pressure on the larger firms to cut costs and, ultimately, lower profitability.

Insurance companies moving in

At the June meeting of the Environmental Bankers Association held in Seattle, there was discussion of the environmental insurance products currently available from a number of insurance companies. Insurance companies are providing Real Estate Environmental Liability (REEL) policies, foregoing the need for the Phase I Environmental Site Assessment. The REEL policy can reportedly provide coverage for clean-up costs from pre-existing contamination unknown at the time the property was purchased.

This policy can also provide third-party claims for cleanup, bodily injury and diminution in property value, third-party claims for contamination which may occur after the inception of the policy date, and specific monetary components of natural resource damages.

During the conference an environmental banker from one of the largest U.S. banks noted that a recent real estate transaction of approximately 100 gasoline service stations was completed using this type of insurance. No Phase I sites assessments were completed, and no C&E businesses were involved in the transaction.

Using this example, and using an average estimated cost of $20,000 per service station, which may be a low estimate, for a Phase I/Phase II investigation and/or remediation at each service station, up to $2 million of work for a large, medium or small C&E firm was insured away.

If the insurance companies can create a product for a single property transaction, the impact to C&E firms is enormous. One may argue that all this approach simply prolongs the problem creating work in the future when an assessment will be required from a claim. My response is yes that's true, but focusing on potential future work will not solve the immediate problem of the shrinking demand for environmental C&E services.

Until the end

Even with the apparent impending decline for the environmental industry, there are always new opportunities. Locally, the effect of the listing of the chinook salmon on the Endangered Species List will create work for the C&E companies with natural resource capabilities. It is possible that Superfund could get reauthorized, and some Superfund activity may start again. The insurance industry may not make the financial returns it needs with the environmental insurance, causing them to leave the market.

In any case, the environmental C&E business will significantly change within the next two years, and the end result will be fewer C&E companies and fewer professionals working in this industry.

Copyright © 1998 Seattle Daily Journal of Commerce.