Mehan on Water: God Gave Us the Water, but Who Pays for the Pipes?

A water utility consultant told me of a nun who came to a public hearing on a proposed rate increase and testified that because God gave us the water, the people should not have to pay for it. This might be called the sacramental view of infrastructure financing.

The consultant responded, “Sister, God did give us the water; but who is going to pay for the pipes, the pumps and the water treatment works?”

The good sister’s view is consistent with the finding of pollster Frank Luntz that 54% of Americans believe clean water is a right, not a privilege.

This occurrence illustrates the challenges of financing water infrastructure in the U.S. The estimates of an investment gap over the next 15 years range from hundreds of billions of dollars to more than a trillion.

Four years ago, the U.S. Environmental Protection Agency (EPA) unveiled its Four Pillars of Sustainable Infrastructure to meet the challenge of an aging infrastructure. It aimed for a sustainable regime of infrastructure investment and management, which looked at water and wastewater facilities in a broader context: the demand side as well as the supply side, the watershed as well as the treatment works, and the responsibilities of ratepayers themselves rather than taxpayers from elsewhere.

The Four Pillars consist of Better Management, Full-Cost Pricing, Efficient Water Use and Watershed Approaches to Protection.

 

Full-cost pricing

You could build the entire house of water infrastructure on just one pillar: Full-Cost Pricing. This is arguably the first among equals.

The U.S. has some of the lowest water rates of any of the free-market democracies that are members of the Organisation of Economic Co-operation and Development (OECD). The average American household pays more for soft drinks in a year ($707) than for water and wastewater charges ($474). The Congressional Budget Office claimed that even if you paid for the entire infrastructure investment “gap” through rate increases, that same household would be paying less than 1% of its average household income.

James Wiemken, director of Standard & Poor’s Credit Market Services, has noted the credit implications of water rates for water and sewer utilities: “A utility’s ability to implement policies and procedures that garner the support of ratepayers for the additional revenues required to support these needs will become more important to the [credit] rating,” he said.

Encouraging Full-Cost Pricing also incentivizes the pillars for Better Management and Efficient Water Use because it encourages efficiency, conservation and sound management overall.

The majority of our citizens are served by public systems. Therefore, a pricing decision is essentially a political decision, which is equated with a tax increase, a political root canal.

An August 2002 Government Accountability Office (GAO) report on its survey (www.gao.gov/new.items/ d02764.pdf) of several thousand drinking water and wastewater utilities indicated that 29% and 41%, respectively, were not generating enough revenue from user rates and other local revenue sources to cover their full cost of service. Roughly one-third of the utilities deferred maintenance because of insufficient funding, had 20% or more of their pipelines nearing the end of their useful life and lacked basic plans for managing their capital assets.

 

Better management

According to some experts, greater use of asset management could, conservatively, slash 20% off the total infrastructure gap if water and wastewater systems followed the lead of Australian and New Zealand systems, Seattle Public Utilities and Orange County, Calif., in implementing this important tool for maintaining our precious capital assets.

Asset management includes the definition of the level of service; performance goals, asset identification and valuation; failure impact evaluation (“criticality” analysis); risk management; and continuous improvement.

Hunter Water Corp. in New South Wales, Australia—a combined utility serving half a million people—cut its operating cost by more than 40% through its asset management program. It also reduced capital expenditures by U.S. $185 million (about four years of planned capital expenditures).

Seattle Public Utilities reported capital savings of over $150 million, an excess of 15% savings for its six-year Capital Improvement Program. It also realized savings on operations and maintenance of approximately 10% for its drinking water and drainage/wastewater business lines.

And consider the pillar for the Watershed Approaches to Protection. Virginia’s new law establishing point-to-point source water quality trading of nutrient credits for the improvement of Chesapeake Bay encompasses 125 “significant dischargers” (105 POTWs and 20 industrial facilities) under one general permit. A cap-and-trade system allows one discharger to meet its regulatory goal by using the pollutant reductions created by another source that has lower pollutant control costs. It capitalizes on the economies of scale and control-cost differentials between dischargers.

The consulting firm CH2M Hill estimated a 32% savings for Virginia dischargers through 2010—$1.1 billion versus $1.6 billion. The savings percentage drops to 19% by 2030, but the absolute savings are still significant. The total compliance costs drop from $2.2 billion, without trading, to $1.79 billion with trading.

 

Call in the lobbyists

Not everyone is enamored with the Four Pillars of Sustainable Infrastructure. Some prefer hiring lobbyists. One lobbying firm in Washington marketed its services to municipal water systems seeking budgetary earmarks as the means to garner a “fair share of buried federal treasure.”

Congressional earmarking or diversion of federal dollars from the Clean Water Act’s cost-effective State Revolving Fund (SRF) amounted to as much as 16% of total SRF dollars, for a total of $6.5 billion (FY 1989 through FY 2005). The number of earmarks increased from 46 in FY 1995 to 669 in FY 2005.

These earmarks are grants, not loans, for 55% of the project. They do not recycle or revolve back into the SRFs. They relieve the utility of the minimal discipline of repaying the loan principal, which normally comes with below-market interest rates. They are awarded on the basis of political clout instead of a state’s watershed priorities.

 

Serious, but not hopeless

The water infrastructure financing situation is serious, but not hopeless. The EPA Gap Report (www.epa.gov/owm/gapreport.pdf) estimated the infrastructure investment gap over time.

If you look at its mid-range cost figures over 20 years, assuming a revenue growth scenario of 3% over and above the rate of inflation, the capital cost estimates drop from $122 billion for clean water to $21 billion.

For drinking water, the capital costs drop from $102 billion to $45 billion.

Operations and maintenance (O&M) costs also decline to more manageable levels under the revenue growth scenario. The O&M clean water mid-range estimate is $148 billion under the no-growth scenario, but is only $10 billion under the revenue growth scenario. For drinking water the numbers are $161 billion and less than $1 billion, respectively.

And rates are rising. An annual survey of 51 water systems in the U.S., conducted by NUS Consulting Group of Park Ridge, N.J., found the average price of water climbed 3.5% from July 1, 2004 to July 1, 2005.

The average cost of water was $2.34 per 1,000 gal, with the highest price being paid by residents of Huntington, W.Va., at $5.49 per 1,000 gal and the lowest by residents of Greenville, Miss., at $0.80 per 1,000 gal. The national average rose to $5.78 per 1,000 gal when related sewer costs were included, an increase of 5.3% from July 2004.

So there is not a static environment relative to the calculated infrastructure gap. The gap is a construct, which assumes all other variables are constant on both the supply and the demand sides of the equation.

We can close the gap through a consistent program of adequate and equitable water rates (including differential adjustments for low-income users) and sustainable practices—most, if not all, of which are within the control of the water systems themselves.

There is the possibility of a Fifth Pillar of Sustainable Development for the concept of Public-Private Partnerships (PPP) for infrastructure financing.

Virginia will be adding four HOTLanes to the existing eight-lane freeway around Washington, D.C., called the Beltway. Under a statute authorizing PPPs, Virginia will utilize private or concession financing, which will price access to the new HOTLanes, based on levels of congestion or volume. The original lanes will remain free to all comers.

These kinds of creative financing arrangements are rare in the water sector, at least for the major publicly owned treatment works and public drinking water systems. Yet, they illustrate the true value of public assets that are basically underperforming financially or failing to capture their true value in their rate structures.

If ratepayers can be convinced that fair, efficient, cost-effective ways exist to finance and manage their water and wastewater systems, they will be persuaded to invest in these assets and their long-term maintenance.

 

G. Tracy Mehan, III is principal with The Cadmus Group, Inc. He can be reached at 703/247-6000 or by e-mail at gmehan@cadmusgroup.com.

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