Addressing America’s Aging Water Infrastructure:
Where Will the Money Come From?
By John Kersten & Robert Ryall Sep 18, 2012
The renewal and replacement of infrastructure is one of the greatest challenges facing the water industry. Cost estimates for needed system investment range from the hundreds of billions of dollars to trillions of dollars by 2035. Regardless of the exact cost, our water and wastewater infrastructure must be rehabilitated, and the longer the industry puts off the problem, the greater the odds of catastrophic failures.
Funding this massive renewal of water and wastewater infrastructure will be the primary focus for many utilities. Studies by the U.S. Environmental Protection Agency (EPA) and the GAO predict an investment-funding gap of more than $500 billion for upgrades and repairs to public water and wastewater systems, many of which were constructed 50 to 100 years ago. Cities, towns and communities across the nation face major funding challenges over the next 20 years to replace aging and worn out water and wastewater infrastructure. Capital investment for such projects will be difficult as many states and local governments face mounting budget deficits, revenue shortfalls and opposition to new or higher taxes.
The best way to confront this issue is to address the need immediately by correctly analyzing system needs, developing long-term asset management plans and thoughtfully finding funding sources. Perhaps most importantly, we will need to find the courage and political will to raise rates to fund these improvements appropriately. Patchwork and marginal actions today will only lead to even larger challenges tomorrow. Below are five areas that should be considered by water and wastewater utilities to address this looming crisis and bridge the funding gap:
Long-term Asset Management Plans
There is no doubt that significant dollars will be needed to fund renewal and replacement. But what tools will be there to support the industry in the future? Tools to increase efficiency and effectively manage assets will be the areas given the most future emphasis. Such tools allow utilities to do more with what they have and find ways to do so as economically as possible. Implementation of comprehensive asset management programs can help owners more efficiently and effectively manage assets, as well as identify, track and plan renewal and replacement.
Many utilities believe they have an asset management program in place. However, this is typically no more than an asset tracking system that inventories pipes, parts and pumping systems. An effective asset management program combines the processes, systems and people to manage assets throughout their entire lifecycle. This includes creating processes to evaluate asset condition and evaluate replacement systems that track and prioritize capital improvement projects and organizational constructs that maximize efficiency. Asset management plans should detail which assets need to be replaced, when, and at what cost, with replacements planned according to risk, asset criticality, condition and performance. Water utilities that have good asset management programs in place will be able to justify their plans as optimal with the right level of investment to meet the required service levels at the appropriate level of risk. This will make it easier to attract financing.
Asset management has become more important as water and wastewater utilities seek lower-cost financing opportunities to fund capital projects. Some states have begun to offer financial incentives to utilities with bona fide asset management programs. These incentives typically come in the form of interest forgiveness or lower interest rates, which provide ranking advantages and significant cost savings over the life cycle of the loan. These reductions continue for future State Revolving Fund requests and can lead to significant savings over the term of a utility’s capital improvements program. The benefits can be significant and far outweigh the cost of implementing an asset management program.
Maximum Use of Grant Funding
Federal and state governments have created many programs designed to ensure local communities have the funds needed to maintain critical infrastructure and daily operations of their water systems. The key to a successful funding pursuit is to identify where the utilities needs coincide with the state and federal funding agency target initiatives. Agency initiatives continually evolve to meet the current environment, with primary targets similar to Triple Bottom Line (social, environmental and financial) considerations.
In addition, leveraging of multiple funding agencies for a common project or initiative contributes to the overall success of funding pursuits. Funding agencies want to be associated with successful projects. Utilities that engage multiple funding agencies are more likely to identify the funds they need.
Another consideration for funding success is to include alternative funding in the planning phase of a project, with the intent to shape the project to maximize grant and low-interest funding. Facility design should leverage available funding support and include green optimization measures in an effort to participate in set-aside funding. The goal is to develop a funding initiative around projects that would decrease or eliminate the need to raise rates through the use of outside funding sources – therefore bridging the shortfall.
Collaboration between engineering, design and alternative-funding teams to provide utilities with multiple avenues for outside funding can yield tremendous long-term results. Proper planning, design, construction and funding of a holistic aging infrastructure improvement program can mesh with key funding agency initiatives and priorities, helping utilities secure outside funding for critical projects.
Many utilities count on the revenue bond market as their primary financing vehicle. Although it will play the most significant role in funding future renewal and replacement, the bond market has changed. Post-2008, financial due diligence standards are significantly more stringent than before, making it more difficult to access the bond market at the best possible interest rates. Utilities will need to put much more effort into developing, executing and managing comprehensive capital and financing plans. The days of not following through on commitments regarding rate increases, capital plans, organization and operations are over. Rating agencies and institutional investors expect significantly increased disclosure of operating and financial conditions, as well as solid reports on non-financial, regulatory, management and local economic conditions in order for municipalities to obtain favorable ratings and interest rates.
Even with the more stringent requirements, the revenue bond market will be the primary financing vehicle for public sector water and wastewater utilities. But it is not likely to fully cover capital needs. Utilities will have to search for alternative funding streams, many of which have not yet been considered by the public sector.
Given this state of the industry, where will the money come from? Is it available? Can we access it? What’s the catch? The catch is that it might not come from the same sources or as easily as it used to. After utilities maximize application of cost-saving measures and access available grant money and low-interest-rate government loans, the balance of capital needs will have to come from somewhere else.
Few would disagree that infrastructure renewal has a strong impact on the financial health of utilities. Once they examine physical assets, estimate deterioration rates and analyze and quantify the operational impacts of aging infrastructure, utilities are challenged to find the resources to meet identified needs.
Numerous industry forecasts, reviews, outlooks and projections indicate that the capital requirements to solve the aging infrastructure problem are so large that the public sector will have to consider other sources beyond traditional bond financing. Hurdles can vary with location and may reflect political resistance, management resistance, perceptions regarding legal constraints or the costs and value of potential financial arrangements. To capitalize on the use of alternative funding mechanisms such as privately-managed infrastructure funds and public–private partnerships, further education is required to showcase the potential benefits both in financing and risk management. Ample experience from countries such as the United Kingdom, Canada and Australia can provide insight on various options to address funding gaps.
Private Activity Bonds
Private activity bonds (PABs) are a type of municipal bond that can allow communities to tap into private investment. Instead of being issued to finance facilities’ for general public use, PABs are issued for the benefit of a private entity. Certain types of PABs qualify for tax-exemption. One limitation to PABs is a volume cap in which the federal government allocates the volume of PABs to the states, and then each state uses its own unique procedure to further allocate PABs to municipalities and projects. However, there is support in House Bill 1802 (the Sustainable Water Infrastructure Investment Act of 2011) and Senate Bill 939 (the Sustainable Water Infrastructure Investment Act of 2011) for removing the volume cap for PABs used for water and wastewater infrastructure.
Black & Veatch’s 2012 Strategic Directions in the U.S. Water Utility Industry report, published in June, confirmed that the financial needs of water utilities are truly the overarching challenge for the industry. It outlined the need for innovative financing to help organizations that can’t significantly raise rates and meet infrastructure repair and upgrade needs. Utilities and the consultants they engage need to be alert to new and evolving funding options. Enterprises that thoroughly consider these options and chart a course that focuses on where money will come from as well as where it will go, will be better able to serve communities well into the future.
John Kersten is a vice president in Black & Veatch’s management consulting division and Robert Ryall is a principal consultant in Black & Veatch’s management consulting division.