Guest Commentary: Challenges and Opportunity in the US Water Infrastructure Market

March 26, 2015

Trends in the US infrastructure market are constantly shifting, driven by economic cycles, regulation, technology, and growth. Today, there is arguably no sector facing a more critical shortfall between demand and investment than the US water market. The country’s water and wastewater infrastructure suffers from subpar conditions throughout the supply chain, encompassing water intake, diversion, transportation, storage, treatment, and delivery. Despite the obvious and well-documented needs, economic and governmental factors have hindered the market’s ability to address demand.

Projected Market Growth
Since 2010, when economic stimulus measures boosted water and wastewater construction activity, spending in this market has declined due to municipal budget challenges and a lack of federal government emphasis. Significant investment is needed to reduce freshwater contamination and wastewater system failures that pervade our water infrastructure. A leading provider of management consulting and investment banking to the engineering and construction industries projects that the combined water and wastewater construction market will grow 2.5% annually over the next five years to $40.3 billion. While forecast expansion is steady, the rate of projected growth is tempered by uncertainty surrounding access to necessary funding.

Capital expenditure in the US water and wastewater market slowed significantly in 2013 while municipalities continued to deal with budget uncertainties. Analysts at Global Water Intelligence expect capex growth to accelerate in 2015. Investment is expected to improve to address the growing volume of repair, refurbishment, and replacement projects, as well as increase environmental and efficiency demands.

In a 2013 study, the Environmental Protection Agency (EPA) gave the US water and wastewater infrastructure a subpar “D” grade. Portions of the water delivery system date back more than 100 years, and there are an estimated 240,000 water main breaks each year. EPA estimates $384 billion in investment is required over the next 20 years to repair and sustain our water system. Similarly, wastewater infrastructure requires an estimated $300 billion in investment over the next 20 years, with the majority needed to fix and expand pipes to reduce leaks and sewer overflows. Roughly 900 billion gallons of untreated sewage is discharged each year due to aged and damaged systems.

Last year, Los Angeles experienced a rupture in a 93-year-old water main that spilled 20 million gallons of treated water in a matter of hours amid the region’s most severe drought in centuries. While this loss volume is minor compared to the city’s daily water consumption, it succinctly illustrates the troubling nexus of aged infrastructure, investment need, and consumer concern. The broader water industry faces unprecedented pent-up demand to rehabilitate and construct treatment infrastructure. The recession exacerbated this dynamic as access to capital waned, leading to a historically high project backlog.

Rising Industrial Demand
Growing industrial markets are competing with other end-use markets for limited water resources. As a result, industrials are under pressure to self-supply water, especially in drought regions. The power sector remains the largest industrial consumer of water, though the North American oil and gas boom is contributing to the increased stress on surface and groundwater supplies. Notably, the growth in enhanced and unconventional oil and gas extraction methods is driving demand for water treatment, reuse, transport, disposal, and storage. This trend extends across the continent, from the Alberta oil sands to the bottom of the Eagle Ford Shale in northern Mexico.

As regulations governing oil and gas practices evolve, participants must address the problem of treating, recycling, and disposing increasing volumes of process water. Analysts predict water treatment needs in oil and gas extraction and processing in the US and Canada will more than double over the next five years.

The North American mining industry is another growing industrial water market, as companies require increased access to reliable water supplies for ore extraction and processing as well as for treating mine effluents. In light of ore price volatility, mining companies seek more cost-effective water solutions to boost processing efficiency. Pharmaceutical and chemical industries, among other industrial markets, are also commanding improved solutions to water access and processing efficiency due to regulatory, scarcity, and cost factors. A common theme across all industrial water appli­cations is the growing need to preserve limited freshwater resources for domestic use. Construction, engineering, operations and maintenance, and equipment companies are turning to industrial markets to augment their municipal water and wastewater market exposure.

Persistent Drought Conditions
Regions throughout the US, including Texas, Oklahoma, California, Arizona, New Mexico, and Nevada, are suffering from severe, multi-year drought conditions. Many key water reservoirs in affected areas are at historically low levels. Serving a seven-state region, the Colorado River basin has lost 17 trillion gallons of water since 2004. These surface and groundwater conditions are forcing municipalities to turn to alternative water technology, including desalination and potable water reuse. States such as California and Oklahoma are streamlining the permitting process for such projects, which may accelerate broader adoption of desalination and water reuse nationwide in the coming years.

Regulation
EPA continues to push more stringent regulations through to the water and wastewater industries. Under the Safe Drinking Water Act, EPA is mandating enhanced surface water treatment and water disinfection to improve public water system quality. Such rules encourage innovation and investment in more effective technology, such as ultraviolet disinfection, membrane, and multi-barrier disinfection systems. With the Clean Water Act, an increasing number of utilities are operating under federally mandated consent decrees, which often require substantial investment over time to comply with stormwater and sewer water discharge standards. Nutrient management regulations are also driving demand for wastewater treatment upgrades, including improved biological and nutrient removal technologies such as membrane bioreactors. While not significant catalysts for increased spending at this point, these regulatory measures continue to expand and shape better industry practices.

Access to Funding
In prior years, utilities and municipalities counted on an abundant water supply, pricing flexibility, and ready access to capital markets to support infrastructure funding needs. In contrast, today’s market is characterized by regional water scarcity issues, revenue shortfalls, and more disciplined municipal bond markets. Faced with lingering budget challenges and limited funding resources, federal, state, and local agencies are unable to fund the necessary infrastructure project costs.

Recent federal programs seek to bridge the water infrastructure funding gap and broaden investment sources. The Water Resources Reform and Development Act passed in June of 2014 will allocate $12.3 billion to fund water resource projects over the next 10 years. Included in this legislation is the Water Infrastructure Finance and Innovation Act, which will provide $350 million in direct subsidies for Army Corps of Engineers and EPA projects. While this level of federal funding is modest relative to the outstanding demand, this loan program can support as much as $3.5 billion in water infrastructure projects over the next five years. In addition, the White House recently launched a $10 billion loan fund aimed at financing water and other infrastructure projects in rural areas.

These federal programs are all the more interesting in that, while limited in size and scope, they encourage private investment in water infrastructure. The US lags behind many international markets in utilizing public-private partnerships (P3) to not only fund water and wastewater projects, but also to operate and own water services. In 2014, private investment activity picked up, highlighted by the Detroit Water and Sewage Department’s proposed P3 to take over the city’s $800 million water and wastewater system. Facilitating private investment in the US water and wastewater market is an important path to growth in the coming years for all industry stakeholders.

Opportunity
Water and wastewater are not speculative or alternative investment markets. The critical needs throughout the municipal and industrial water ecosystems are mounting. While project funding remains unpredictable and in a transitional state, this market offers significant opportunity in the coming years. Both municipal and industrial growth will benefit construction, engineering, and O&M services firms that are well-positioned in this space. Underpinning this expected rise in activity is the continued evolution of water technology and equipment as well as public and private funding mechanisms. The volume and diversity of demand in this market are only increasing due to performance, economic, regulatory, and environmental factors. These factors heighten the need for collaboration, innovation, and broader funding solutions to narrow the gap between demand and investment.

About the Author

Greg Powell

Greg Powell is a vice president with FMI Capital Advisors, Inc., FMI Corporation’s Investment Banking subsidiary.

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