Public Works Financing – May 2001 issue

Senate Shakeup may impact on financing infrastructure costs;
Debra Coy estimates:
full rate-payer cost increase between $11 to $40 per household per month

By Debra G. Coy

May 24, 2001

The day the Jeffords story broke in Washington, a scheduled hearing in the Senate subcommittee responsible for water and wastewater infrastructure was postponed, in deference to floor votes on the tax bill. Instead, the scheduled witnesses had a "discussion" of the issues with subcommittee staff, amid some gallows humor about how the Republican staffers would soon no longer be in charge. Indeed, we expect that newly Independent Senator Jim Jeffords himself will take over the chairmanship of the Senate Environment and Public Works Committee in the next few days.

This isn’t likely to create a sea change, since Republican committee chairman Bob Smith of New Hampshire and several other Republican members were moderates themselves, oriented toward bipartisan compromise. Nevertheless, the tone of debate could change with the Democrats gaining the leadership bully pulpit in the Senate. Though Clean Air Act issues have taken precedence on the environment committee, given their overlay with high-priority energy policy initiatives, water infrastructure isslowing slowly moving up on the agenda.

At least some policymakers are beginning to view the neglect of investment in water and wastewater as the next infrastructure crisis in the making. The drumbeat of calls from municipal groups for more federal money to help avert this crisis will probably only get louder, with Democrats typically viewed as more willing to lend a sympathetic ear to pleas for funding for public projects. In fact, one of Jeffords’ reasons for quitting the GOP was the proposed reduction in education funding to help pay for the $1.4 $1.35 trillion tax cut.

Certainly the public utility representatives attending the discussion in the Senate subcommittee this week remain very focused on their large funding needs, which they believe must be met by more government money. Both large cities and small rural areas say that available funding under the State Revolving Loan funds isn’t helping them nearly enough.

There has been much talk in recent hearings and public forums about the so-called "Nessie Curve," depicting the rising cost to replace the previous generations of water infrastructure in the next couple of decades, punctuated by monster-ish humps of additional capex for new water treatment plants. The American Water Works Association says that a new study of 20 utilities facing the Nessie Curve estimates that new capex will cost about $1,600 per household, on average, over the next 30 years, while costs for smaller systems could range up to $6,000 per household over the same period.

Frankly, we don’t see this as a major problem. For example, $1,600 in spending, financed over 30 years at, say, 7%, adds up to an average additional payment of about $11 per month per household. Using the same simple 30-year mortgage calculation, the high-end cost estimate of $6,000 per household would suggest an incremental payment of $40 per month, a problem for some households but not others. These numbers would of course be adjusted by actual timing of spending and other costs, such as new treatment standards, that might arise. But we still think there’s a lot of room for customers to pay directly for infrastructure improvements, rather than burying the costs in the morass of general government budgets.

Given these concerns about rising customer rates, municipal utility representatives were asked by subcommittee staff this week about the possibility of providing government assistance directly to end-users who needed it, rather than giving grants to utilities. The reply was that such an approach would be "very cumbersome." Perhaps.

The AWWA study says the replacement value for the 20 water utilities in its study now averages about $2,400 per capita, or close to $10,000 for a four-person customer household. We note that for the largest investor-owned water utilities we follow, net utility plant now runs about $2,000 per customer. Average capital spending per customer in the past three years is about $170-180 per year. Capex costs typically exceed operating cash flow in a given year, and as we know, this investment cost is funded with a roughly 50-50 combination of debt and equity. Rates are set, in approximately three-year cycles, by public utility commissions to recover this investment, with a typical ROE of around 10%. Average utility revenues per customer were around $500 in 2000 (including a mix of residential, commercial, and a few industrial customers), or around $40 per month per customer.

Overall, this system that has worked well. For regulated investor-owned utilities, infrastructure investment is mostly up to date and the customer rates that fund that investment are still reasonable. (However, we do note that investor-owned utilities generally don’t face the problem of declining population faced by some older cities.) As replacement costs continue to rise, investor-owned utilities have been forced to create as much operating efficiency as they can, reducing their costs to help keep local rate increases within the realm of political acceptability. We think this motivation would inevitably be compromised if a utility had access to government grants to make up for funding shortfalls.

While the Senate shakeup has Washington abuzz, we think Mr. Jeffords is likely to remain the moderate influence he always has been. The water infrastructure funding debate is far from over, but we continue to think that even with Democrats controlling the Senate, getting Congress to agree to a large new federal grant program for water and wastewater remains an uphill battle.

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