Water Affordability | Part 2
You can lead a horse to water, but how is he going to pay for it?
In the first installment of our blog series on water affordability, we talked about the financial challenges many utilities across the country are facing: soaring water rates, increasing operating and capital improvement costs, and insufficient funding to keep up with the demands of a deteriorating infrastructure system. Meeting these needs without exacerbating ratepayers’ ability to afford this vital service requires deliberative, proactive financial planning by water utilities. In Part 2 of our three-part series, we will take a closer look at strategies utilities are employing to secure greater financial stability necessary for tackling these challenges. These include financial solutions to help spread capital costs over time, opportunities to reduce operational costs, and tools to target and prioritize capital improvement planning.
Explore Capital Financing Tools
Since the 1980's, federal spending on water and wastewater infrastructure has steadily declined while state and local government spending has rapidly increased. As federal spending has decreased, tremendous pressure has shifted onto local governments, and their ratepayers, to foot the bill of necessary infrastructure improvements and supply expansions. To pay for these capital projects, localities have two options: pay-as-you-go and debt financing. In the pay-as-you-go model, utilities save up money from existing sources of revenue until they have enough to pay for a capital improvement project, or match annual capital spending to annual revenue capacity. In the debt financing model, utilities secure funding for capital projects through various financing mechanisms, such as more traditional sources (e.g., general obligation bonds, state revolving loan funds) and more innovate types (e.g., public-private partnerships). Due to the significant capital investment required by water and wastewater infrastructure projects, utilities often look to debt financing to fund system upgrades.
Within the portfolio of debt financing strategies, public-private partnerships (P3s) have been garnering more and more attention as an alternative solution to more traditional types of funding. This type of financial model is driven by “performance-based” contracting—in other words, private investment funds the upfront capital costs of a project and if/when performance targets are met, the governmental entity is responsible for paying back the investors according to the agreed-upon terms. By incorporating private capital into public sector financing, P3s transfer project-related risks from the utility to the private entity.
While P3s are not a new concept in the water/wastewater sector, the structures of P3 financing models are constantly evolving. Just last September, DC Water became the first water utility to introduce an environmental impact bond (EIB) to fund its green infrastructure pilot project. DC Water secured the $25 million tax-exempt EIB from Goldman Sachs and the Calvert Foundation. Depending on how effective the green infrastructure installations are at reducing runoff, the EIB contract requires the following contingent payments:
What makes this financing solution so appealing is that it helps mitigate the risks of the pilot project falling short of expected targets. For the DC project, performance outcomes will be measured five years after the project has been installed. If the project performs as expected, the EIB will essentially function as a 30-year municipal bond, spreading costs over time (and lowering annual impacts to ratepayers). If the project over-performs, DC Water will make a $3.3 million contingent payment to investors, which is still a very cost-effective outcome for DC Water because it validates less-expensive green infrastructure over more-expensive gray infrastructure. On the other hand, if the project under-performs, DC Water will recoup a $3.3 million contingent payment from investors, covering a significant portion of DC Water’s interest payments for the first five years. For more information on EIBs, check out this report published by Duke University.
For an extensive list of traditional funding options available state by state, check out the Environmental Finance Center Network’s resource.
Identify Opportunities to Reduce Operating Costs
Reductions in operating costs can redirect funds towards capital improvement budgets. Two of the largest areas where utilities can optimize their operating processes include energy management and non-revenue water.
In most instances, energy usage represents the largest controllable expense in a water system’s operating budget. The energy costs associated with water production are also quite variable as the price of energy rises. Energy management programs allow water utilities to reduce operating costs and dedicate savings to capital improvements and debt financing. Due to their short payback period, energy efficiency projects can generate quick, long-lasting savings for utilities. The following table illustrates the potential cost savings attributable to various energy efficiency technologies.
To fund these projects, utilities can use financing options such as Internal Energy Revolving Funds (aka Green Revolving Funds) or Energy Savings Performance Contracting. For more information on energy management strategies, check out the EPA’s website and the Environmental Finance Center Network’s tools for small water systems.
Another approach to optimizing operating costs involves reducing non-revenue water. These water losses stem from a number of sources: real water losses/leakages, illegal water use, inaccurate meter readings, etc. Water loss rates vary from water system to water system, but average water loss is 16%, and of this amount, 75% is recoverable. The first step in addressing non-revenue water is to establish a water loss control program to audit system losses, assess system characteristics, and identify system vulnerabilities. The fixing and replacement of leaky pipes involves significant capital investment, but smart technologies, such acoustic leak sensors and advanced metering infrastructure (AMI), can greatly enhance leak detection and inform the strategic planning of capital improvements. Beyond helping utilities identify leaks quicker and more easily, these technologies can also help cut down on operating expenses and potentially boost revenue. By reducing real water losses, water systems spend less on chemicals, labor, and energy required for treatment and distribution. In terms of revenue, reductions in non-revenue water also increase revenue capture through more accurate readings.
Likewise, smart meter systems can also reduce meter reading and billing costs since manual reads are no longer necessary. For instance, DC Water attributed a 10% savings in operational and maintenance costs from their AMI rollout. In addition, the City of Santa Barbara completed a study on the cost-effectiveness of AMI for their water system. The table below outlines the potential savings identified by the city in its report.
As each of these examples demonstrates, a utility’s operational efficiency can be significantly enhanced through energy management and smart water loss management. While initial capital investment is necessary to get these projects off the ground, energy and water efficiency measures such as these offer considerable savings over the long-term, making these projects very cost-effective. These savings pay for the project itself over a relatively short period of time, allowing utilities to utilize the remaining life savings for other purposes, including capital improvement upgrades.
Promote Strategic Asset Management
Asset management is a systematic process of deploying, operating, maintaining, upgrading, and disposing of assets cost-effectively. Implemented correctly, it is an integral component of a utility’s daily operations, future system planning, ensuring adequate system performance, and enhancing system resiliency.
Through dynamic asset management software and system modeling, a utility can more accurately measure asset life cycles and predict potential failures, providing them with enhanced ability to prioritize capital improvement projects. Over the long-term, a more strategic approach to asset management and capital planning helps utilities more efficiently allocate capital expenditures by determining the optimal time to replace deteriorating assets. To illustrate these benefits, the Tulsa Metropolitan Utility Authority (TMUA) implemented a pilot program using advanced software analytics to improve the agency’s capital improvement prioritization. In just the first year, TMUA identified 18 water and wastewater projects that could be delayed, which resulted in $11 million in deferred expenses. In the two years that followed, TMUA identified a combined $97 million in cost savings from the delay of additional capital upgrades. For more information on how data can be used to optimize capital infrastructure planning, check out this article from Journal AWWA.
Putting it All Together
Bridging the financial gap that the nation’s water infrastructure system currently faces will require innovative, multi-faceted approaches. Through creative, data-driven financial planning, water systems can mitigate the risks associated with capital-heavy infrastructure projects, achieve greater operational efficiencies, and above all, assure affordable prices for water. Environmental impact bonds, energy management, water loss control management, and strategic asset management are only a few of the diverse array of solutions that can tackle this challenge.
In the third part of this blog series, we will discuss ways in which water utilities can leverage water conservation to address water affordability concerns.