WWEMA 2013: State of water utility sector, business of water discussed at annual meeting

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The WaterWorld staff attended the Water and Wastewater Equipment Manufacturers Association's (WWEMA's) 105th Annual Meeting held on Nov. 14-16 at the Ponte Vedra Inn & Club in Ponte Vedra, Fla.

At the meeting, G. Tracy Mehan, III, principal with The Cadmus Group Inc., spoke about the need for water and wastewater utility managers to shift toward a model of ratemaking that focuses primarily on services rather than commodities in a speech he gave on Friday, Nov. 15.

Titled "Do You Want the Good News or the Bad News First? The State of the Water Utility Sector and the Business of Water," Mehan emphasized the importance of generating support for these robust rate structures. He also highlighted the federal governments' current fiscal situation and how the absence of entitlement spending reform has potentially led to the unlikelihood of significant extended financial support for water infrastructure.

Below is Mehan's speech:

Good morning. First, I want to congratulate all the members of the Water and Wastewater Equipment Manufacturers Association, Inc. on its 105th annual meeting, a very impressive milestone in the history of the water sector in the United States. I also want to thank Dawn Kristof Champney and the board for extending a most generous invitation to speak to you in such lovely and hospitable surroundings here in Florida.

I also hasten to extend my heartfelt congratulations to Dawn on her upcoming retirement, which is both well-deserved and regrettable for those of us who have worked with her on water policy issues over the years. Dawn has been a wise counselor and an even better friend to me since I first moved to Washington in that momentous year of 2001 -- a year which brought home to us just how precious are our friends and family as well as our water and wastewater infrastructure.

Introduction

Today I will discuss the challenges, or obstacles, to greater investment in our water and wastewater utilities and the business of water that supports them. I aim to explore how America's water infrastructure assets are threatened not by terrorists or enemies from abroad but by our own neglect or fecklessness.

G. Tracy Mehan, III speaking at WWEMA's 105th Annual Meeting in Ponte Vedra, Fla.

In his informative and insightful book, The Future of Water (2011), the well-regarded financial analyst, Steve Maxwell (with Scott Yates, co-author), reports that the massive "business of water," of which WWEMA members are a big part, is valued between $500 and $600 billion per year worldwide. This multi-faceted and diversified sector supports the work of utilities in capturing, treating, storing, and reusing water and wastewater. Maxwell has also estimated the U.S. market at $120 billion per year.

Citi Investment Research and Analysis sees global water consumption doubling every 20 years and pegs the world market at $450 billion, slightly smaller than Maxwell's estimate but still sizeable by any measure. Interestingly, Citi also believes technologies are displacing chemicals in water treatment over time. The membrane water treatment market will grow from $1.5 billion in 2009 to $2.9 billion in 2020 for instance.

"As the global water crisis intensifies, we face numerous and daunting political and economic challenges," says Steve Maxwell. "The flip side of this coin represents virtually limitless opportunities for creative and innovative firms to help provide needed solutions."

That is the global perspective. Domestically, the utility and business sectors are suffering from inadequate investments in needed infrastructure and operations & maintenance (O&M), below-cost water rates, declining water consumption (not necessarily a bad thing), and the hangover of the Great Recession. Federal, state and local governments are struggling with their budgets and the long-term crisis of escalating entitlements and under-funded pension funds and health plans for public employees. Let me begin with the role of government in water and wastewater infrastructure funding.

As the saying goes, do you want the good news or the bad news first? I always like to get the bad news behind me. So that is where I will begin.

The Bad News

I do not need to spend a lot of time describing the investment gap relative to the nation's water and wastewater infrastructure which has been documented by EPA, AWWA, NACWA, WEF, ASCE and others. Take just one example, AWWA's 2012 report, Buried No Longer: Confronting America's Water Infrastructure Challenge, which estimated the infrastructure replacement challenge for drinking water to be $1 trillion over the next 25 years. Estimates vary for the wastewater side of the house, but let's call it another $1 trillion for purposes of our discussion.

I came to Washington 12 years ago to run the National Water Program at EPA. Since then, I have followed closely the discussions on possible federal funding of water and wastewater infrastructure. I have heard many calls for a variety of proposals by Congress. If memory serves, there have been recommendations for more funding of the Clean Water and Safe Drinking Water state revolving loan funds (SRFs), a water trust fund, raising the cap on private activity bonds, federal tax credit bonds for watershed restoration zones (WRZs), a watershed renewal bond fund program, a water infrastructure bank, and, more recently, WIFIA (the Water Infrastructure Finance and Innovation Act of 2013).

Congress is considering a pilot program for WIFIA, but the proposal is actively and energetically opposed by 21 state water and finance officials as expressed in their August 16th letter to Vermont Senator Bernard Sanders of the Senate Environment and Public Works Committee. They are concerned that WIFIA may undercut their SRFs, which are already experiencing the death of a thousand cuts as funding is reduced in both Republican and Democratic administrations and congresses.

There was the momentary starburst of the $850 billion stimulus bill in 2008 which generated some spending for water and wastewater infrastructure. But we are not going to see the likes of that kind of spending anytime soon.

Hope triumphs over experience in the water sector. Hope is a theological virtue, not grounded in reason, and springs eternal relative to federal financing. The operative assumption is that the federal government will actually fund a major water and wastewater infrastructure program after it gets around to highways, bridges, inland waterways, ports, entitlement reform, the Affordable Care Act, and paying off wars in Iraq and Afghanistan.

Here is the really bad news. Once again (and again and again…), the Congressional Budget Office (CBO) has offered up a very disturbing picture of America's fiscal situation.

"Between 2009 and 2012, the federal government recorded the largest budget deficits relative to the size of the economy since 1946, causing the federal debt to soar," states CBO in "The 2013 Long-Term Budget Outlook" Further, "Federal debt held by the public is now about 73 percent of the economy's annual output, or gross domestic product (GDP). That percentage is higher than any point in U.S. history except a brief period around World War II, and it is twice the percentage at the end of 2007."

If current law remains the same, there would be a slight decline over the next few years relative to GDP. Thereafter, things deteriorate rapidly. "CBO projects that federal debt held by the public would reach 100 percent of GDP in 2038" -- about the time my new grandson turns 25. This projection does not account for other harmful effects to the economy stemming from this growing debt burden, says CBO. "Moreover, debt would be on an upward path relative to the size of the economy -- a trend that could not be sustained indefinitely."

The federal debt held by the public will likely decline to 68 percent of GDP by 2018. However, this percentage rises to 71 percent of GDP by 2023 "…mainly because of increasing interest costs and growing spending for Social Security and the government's major health care programs (Medicare, Medicaid, the Children's Health Insurance Program, and subsidies to be provided through health insurance exchanges)." Indeed, "CBO expects interest rates to rebound in coming years from their current unusually low levels, sharply raising the government's cost of borrowing."

Recalling the debate in the last presidential campaign over the nation's $16 trillion debt, I thought the problem was actually being understated. Niall Fergsuon, a Harvard economic historian and host of PBS's television documentary, "The Ascent of Money," seems to agree with me. In his new book, The Great Degeneration: How Institutions Decay and Economies Die (2012), he notes that "the statistics commonly cited as government debt are themselves misleading, for they encompass only the sums owed by governments in the form of bonds."

Continues Ferguson, "But the official debts in the form of bonds do not include the often far larger unfunded liabilities of welfare schemes like -- to give the biggest American programmes -- Medicare, Medicaid and Social Security."

"The best available estimate for the difference between the net present value of federal government liabilities and the net present value of future federal revenues is $200 trillion, nearly thirteen times the debt as stated by the US Treasury," argues this native Scot. Ferguson also makes clear that this staggering number does not include state and local governments' unfunded liabilities estimated to be in the neighborhood of $38 trillion.

"These mind-boggling numbers represent nothing less than a vast claim by the generation currently retired or about to retire on their children and grandchildren, who are obliged by current law to find the money in the future, by submitting either to substantial increases in taxation or to drastic cuts in other forms of public expenditure," observes Professor Ferguson.

CBO and Niall Ferguson paint a frightening picture of the fiscal crisis facing this nation over the coming decades absent serious reform. Unfunded liabilities over the years will drive the debt burden beyond anything we can imagine, especially as interest on the debt rises once the Federal Reserve takes away the punch bowl as it inevitably must. Hence my pessimism regarding any new, significant federal outlays for water and wastewater infrastructure on the order of the old construction grants program under the Clean Water Act of 1972.

In fact, since the SRFs are funded out of domestic discretionary spending, an ever-shrinking slice of the federal budgetary pie, I foresee further diminishment of these programs. The federal budget is increasingly entitlement spending, interest payments on the debt and national defense. I exaggerate but not by much. What most Americans think of as "government" (National Parks, the Weather Service, EPA, etc.) is going the way of the Passenger Pigeon.

The downward trajectory of SRF funding led American Water Intelligence, the domestic spin-off of Global Water Intelligence, to speculate, somewhat harshly but possibly presciently, "Perhaps when cities see what is left of SRFs once a budget for 2013 is enacted, they will realize that the financial cavalry isn't coming." ("Will the year's SRF cuts change public sector thinking on government funding?", American Water Intelligence, March 2012, p. 4).

Most of our water and wastewater utilities are run by local governments and municipalities and are subject to political leaders who must face election every four years. For them, raising water rates is equivalent to raising taxes and, therefore, a root canal. Often, they look to water systems as a source of revenue from which they can draw down funds to support, say, public pension funds or health insurance.

Even the casual reader of the trade press or The Wall Street Journal is well aware of the financial predicaments of Illinois, Puerto Rico, Chicago, Detroit, Providence, New Orleans, Jefferson County (Alabama), Harrisburg, and Allentown. All of these cases have unique circumstances, certainly aggravated by the Great Recession; but, taken as a whole, the picture they paint of municipal finance is not pretty.

Tamara Aude, writing in The Wall Street Journal on Halloween ("Crash Crunch Crimps Cities," October 31, 2013, p. A3), related how Fresno, Calif., a city of approximately 500,000, was about out of cash back in April. She quoted the mayor who said, "Our problem is we have no money in the checking account at all." This very low level of cash on hand was among the lowest of 250 largest U.S. cities. The median was 81.1 days. Evidently, Fresno made a bad investment in a municipal garage. What to do? It borrowed money from its water and solid-waste funds.

Another Wall Street Journal article by Mark Peters ("Pension Pinch Busts Budgets," October 30, 2013, p. A3) noted that the median spending on pensions among the country's 250 largest cities rose to 10 percent of general budgets in 2012, up from 7.75 percent in 2007, citing Merritt Research Services LLC. Springfield, Ill., has tripled its payments to its public employee retirement system in the past decade, amounting to 20 percent of its operations budget in fiscal year 2012. In many of its neighborhoods, heavy rains overwhelm storm sewers and roads.

"I have seen kids eight and 10 years old wading waist-deep into it," said Polly Poskin, president of the Harvard Park Neighborhood Association.

One observer estimates the deficit in public pension plans, nationally, at $1 trillion (Rogers Lowenstein, The Wall Street Journal, "The Sorry Tale of Pension Promises," September 21-22, 2013, p. C3). Just this week, a second bond rating agency downgraded the city of Chicago's debt worthiness by three notches because of its failure to address shortfalls in four pension funds (Hal Dardick and Ray Long, "City hit with 1 more debt downgrade of bonds," Chicago Tribune, November 11, 2013).1

The New York Times' Charles Duhigg reported ("Saving U.S. Water and Sewer Systems Would be Costly," March 14, 2010) that DC Water, to its eternal credit, was seeking water rate increases so it can replace its pipes over 100-year-cycles rather than "in three centuries" under the original budget. Still, one local resident complained, "I don't care why these pipes aren't working! I pay $60 a month for water! I just want my toilet to flush! Why do I need to know how it works?"

The estimable George S. Hawkins, the dynamic head of Washington's water and wastewater system, articulates a frustration everyone in the water sector can appreciate: "People pay more for their cell phones and cable television than for water."

"You can go a day without a phone or TV," he adds. "You can't go a day without water."

This disconnect in the mind of ratepayers ― cognitive dissonance really ― can be found all over the country including my wife's home state. A 2010 study of monthly utility costs in Wisconsin demonstrated (see graph below) that customers paid over $140 per month for telephone service (cell and land lines combined) and over $80 per month for electric power. Wastewater charges were less than $40 per month, and water charges were less than $20 per month (MSA Professional Services, Inc., The Cost of Clean: 2010 Wisconsin Sewer User Charge Survey Report, p. 31).2

I dare to say that you could produce a graphic like this for most states in the Union.

Source: MSA Professional Services, Inc., The Cost of Clean: 2010 Wisconsin Sewer User Charge Survey Report, p. 31.

The Good News

Yet, there is good news or signs that the nation ― its communities, its utilities and its ratepayers ― are coming to appreciate the need to invest in their water and wastewater infrastructure.

David LaFrance, executive director of AWWA and a water finance expert in his own right, recently observed that "awareness is increasing about the need to reinvest in and replace water infrastructure," citing survey data from Black & Veatch, Xylem and AWWA itself ("Survey Says…There's a Glimmer of Light at the End of the Tunnel," January 2013, p. 6).

Rates have been going up the last few years, although the percentages often belie the small actual amounts of the increases. But this is progress. True, the averages are lifted by big numbers stemming from consent decrees mandating massive expenditures for remediating combined sewer overflows (CSOs) in older communities. These are sizeable investments although not always cost-effective.

It is also encouraging that Texas voters overwhelmingly passed a constitutional amendment this month to finance state water projects. Proposition 6 takes $2 billion in surplus state money from the Rainy Day Fund to provide loans for water infrastructure. The measure had bipartisan support in a state where drought conditions have been persistent. Texas had not invested in water infrastructure for decades. To paraphrase Rahm Emanuel, you never want a serious drought to go to waste. The vote in Texas reminds us that states can and do play a role in financing infrastructure projects including the capitalization of their SRFs.

Recall that the Erie Canal, America's first iconic infrastructure or public works project, was funded by New York when the federal government refused.

From the perspective of the business of water, the water industry, what will drive further investments in water and wastewater infrastructure in the years ahead? One of the major drivers will be greater regulation of nutrients as has happened on the Chesapeake Bay. The State-EPA Nutrient Innovations Task Group reported in 2009 that of the more than 16,500 municipal POTWs (publicly owned treatment works) nationwide, only 4 percent have numeric limits for nitrogen and only 9.9 percent for phosphorus.

Many states have only narrative criteria for nutrients rather than numeric ones. Permit limits are very difficult to derive from narrative limits given the technical challenges and political push-back. Nevertheless, over time, nutrient numeric limits in NPDES permits will become more common nationally as states and EPA impose and enforce numeric criteria or derive more permit limits from the waste load allocations developed for point source dischargers under applicable TMDLs (total maximum daily loads or pollution budgets required by the Clean Water Act for impaired waters).

Indeed, major investments by point-source dischargers have been driven by strong numeric criteria or TMDLs in places such as the Great Lakes, Florida, North Carolina, and, again, the Chesapeake Bay. DC Water is investing $1.4 billion for a thermal hydrolysis and anaerobic digester system and an enhanced nutrient removal facility at its Blue Plains plant on the Potomac but for the benefit of the Bay downstream. Blue Plains is the largest such plant in the world ("Projects," Water Environment & Technology, July 2011, p. 71).

Stormwater is another focus of increasing regulatory attention. Because of its regional TMDL, the Chesapeake Bay is a leader nationally. However, more stringent stormwater regulation is a national trend given statutory and regulatory mandates. On Chesapeake Bay, agriculture is still the largest contributor of nutrient pollution, but stormwater runoff is the fastest growing.

Conor Denehy of BlueTech Research® has opined that the need for stormwater technology and infrastructure in the U.S. municipal sector will surpass $105 billion over the next 20 years (Conor Denehy, "Stormwater management market set for growth," World Water: Stormwater, Autumn 2013, p. 10).

Many communities are looking at green infrastructure and low-impact development to mitigate stormwater runoff by means of infiltration, reuse and evapotranspiration. Mayor Rahm Emanuel of Chicago just announced a $50 million five-year program at WEFTECH® last month, and EPA Region 3 hosted a conference in Annapolis to explore public-private partnerships (PPPs) to securitize debt, obtain up-front funding, construct, and provide long-term O&M for such decentralized or distributed systems in direct imitation of the approach utilized by the Pentagon now to finance, build and manage most military housing these days. These are all positive developments.

The self-evident deterioration of our infrastructure, which is manifested, say, by water main breaks and collapsing pavement, may finally work its magic on political leaders and ratepayers alike. Steve Maxwell tells the story of the Washington Suburban Sanitary Commission (WSSC), serving one of the wealthiest parts of the country ― the Maryland suburbs of the nation's capital. WSSC experienced a massive water main break just before Christmas 2008. River Road in Bethesda, Md., became, well, a river. A 66-inch pre-stressed concrete underground water main burst setting of a torrential flood which deluged a major artery and stranded motorists. Helicopters, boats and fire trucks came to the rescue, and water was cut off to thousands of customers.

This was just one of 1,709 breaks that year, and WSSC was on a 200-year replacement schedule for its 5,500 miles of water mains. Earlier in 2008, WSSC's commissioners had rejected a new fee of $20 a month per customer to accelerate pipe replacement because they said the flat fee was unfair to low-income customers. Fair enough. But they failed to change the fee to a sliding scale or block rate or come up with any subsidy program for the financially distressed.

"They decided to ask for money from the federal stimulus package instead; however, they didn't get any," writes Maxwell. "Technological advances certainly matter, but what matters most is the ways in which humans use and pay for water," argues Maxwell. "Right now, most people in most countries don't value water very highly, even though they know that without it they would die."

"The most important job utilities around the world may have in the coming decades is convincing people that water is valuable and that it is reasonable to pay more for this luxury than the bargain prices we have traditionally taken for granted," opines Maxwell.

In his book, Maxwell reproduced a table from Global Water Intelligence, a trade press publication, which lists average water prices in terms of U.S. cents on the gallon. It basically confirms that northern Europeans pay twice as much for water as do Americans. They also use less than half of what Americans consume. Quelle surprise. European water systems have larger capital surpluses for capital investment.

By the way, my online research revealed that WSSC's actual rate increases were in the range of 0.0 to 3.0 percent, FY 2000 through FY 2007. From FY 2008 through FY 2012, they ranged from 6.5 to 8.5 percent. I also found an August 22, 2013 letter to the Baltimore Sun from a disgruntled ratepayer from Laurel, Md.,3 complaining that her monthly bills had gone up from $60 per month in 2007 to $160 per month now.

In the long-run, America must invest in its infrastructure. There really is no choice is there?

The Essential Task

The essential task is to educate, communicate and convince customers and ratepayers of the necessity of shifting from an overly-constrained commodity model of pricing to a new and more accurate and compelling services model of pricing. Water and wastewater utilities do sell a commodity like flour or coffee beans or corn. But utilities also provide extremely sophisticated services which are highly technical, heavily engineered and capital-intensive. We need to emphasize, not just the importance of full-cost pricing, but the tremendous value and the benefits and services that water and wastewater utilities provide their customers and ratepayers. This is an important dimension which needs to be reinforced every day, in every message and every interaction that utility managers and personnel have with the public. The story needs to be told.

Given declining rates of water consumption and the difficulty of loading fixed costs (80 percent or more) into a variable or volumetric water rate, the service model is clearly preferable. Of course, some blending of the two might work. You should also build into rates the scarcity value of water, say, in arid or water-short regions of the country.4

These vast complexes of engineering, technical, business and managerial services (which are our water and wastewater utilities), are mostly invisible to water consumers who have been spoiled by cheap water readily accessible. This blissful ignorance must come to an end. If you believe the data on the infrastructure investment gap, you have to believe we have failed to educate the public or make a compelling case to ratepayers.

Water and wastewater utilities, as well as their political and community leaders, need to develop skills in strategic communication, marketing, branding, civic education, and outreach. They need to emulate a competitive business enterprise, not a traditional government monopoly. AWWA's 2004 publication, Avoiding Rate Shock: Making the Case for Water Rates, was a ground-breaking effort in this regard. And WEF's WATER'S WORTH IT campaign is also a very important contribution.

I am pleased that both municipal and private water sector associations and companies have come together in the very promising Value of Water Coalition (www.thevalueofwater.org) to inform Americans of the value of water and the challenges facing the nation's water infrastructure. When former WEF Executive Director Jeff Eger first conceived of a public campaign like the Value of Water, he often compared the water sector's anemic efforts with the "Clean Coal" campaign, which invests tens of millions of dollars in media and messaging. Let us pray that the new Coalition can achieve significant market penetration in the days ahead. If I have any advice for the Coalition, it is to stay focused on ratepayers, not on Washington.

In addition, I want to recognize the water reuse industry and its customer utilities which are pioneering sophisticated communications strategies to promote indirect potable reuse around the country. Can direct potable reuse be far behind?

We also need to pay attention to governance issues more than we have to date. In Australia, the world leader in water management, utilities are regulated by an independent price regulator who sets the Weighted Average Cost of Capital (WACC) and the model used to set prices at arm's length from elected officials. This approach is unlikely to be adopted here in the States. Nevertheless, governance of municipal water and wastewater facilities might benefit from greater distancing from elected officials.

There are many examples to choose from throughout the country. I am not advocating an unaccountable technocracy, but, rather, greater reliance on public corporations, commissions and other bodies established and appointed, but not directly controlled, by elected officials. We need to shield water pricing decisions from political interference and the undue influence of the electoral cycle.

One final thought regarding the future financial success of WWEMA and its members: Robust economic growth in the business of water is to be found in international markets, especially in dynamic, emerging economies and countries. In this competitive, globalized world, the Israeli water industry is exemplary. Its exports of water products have tripled in the past five years and now total $2 billion. Please take note: the U.S. is its biggest customer (William Booth, "Israel knows water and wants to cash in," The Washington Post, October 26, 2013, p. A8).

A portfolio approach to managing business risks requires greater internationalization of the water sector given that our domestic market is very mature. If Steve Maxwell and Citi Investment Research and Analysis are accurate in their estimates as to the magnitude of global water markets, it is well past time to move into them.

Conclusion

I hope I have provided a realistic assessment of the water sector's current predicament while discerning a path forward to greater investment in its infrastructure. I share the view of Clifford Winston of the Brookings Institution who, in commenting on the transportation sector, claimed we were not in an infrastructure crisis as much as a pricing crisis. "And if we can get the prices right, that will do an awful lot to improve the condition and service of our infrastructure."5

References

1 Accessed at www.chicagotribune.com/news/local/ct-met-chicago-bond-rating-1112-20131112,0,959918.story on November 12, 2013.

2 My thanks to Gil Hantzsch, P.E., Vice-President of MSA Professional Services, Inc., for providing me with this information.

3 Name withheld, "Let WSSC know how you feel about increasing water rates," Baltimore Sun, August 22, 2013.

4 My thanks to economist David Zetland for these formulations.

5 Quoted by James Pethokoukis in his AEI blog post, "Actually, America doesn't have a trillion-dollar infrastructure crisis," November 4, 2013, at www.aei-ideas.org (accessed November 5, 2013).

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