Water and Sewer Financial Capacity and Affordability

The Environmental Finance Center conducted a policy analysis on the financial capacity of utilities. The analysis provides utilities and funding organizations with quantitative information at the community/utility level on the ability of utilities to meet anticipated capital financing challenges. As part of the analysis, the EFC has researched recent reports and studies on documented needs and financial capacity. The study focuses on North Carolina and other EPA Region IV states (Tennessee, South Carolina, Mississippi, Florida, Georgia, Alabama, and Kentucky).
Region IV Capital Needs

Excerpts from the study:

The financial health of a utility has a major effect on its ability to provide safe drinking water and environmentally sound wastewater treatment. The financial challenges facing the water industry as a whole have been well documented over the last few years with the release of a number of high profile "financial gap studies" by the EPA and the Water Infrastructure Network. The numbers and approach found in each of the studies vary slightly, but they all say basically the same thing - the U.S. water industry will need billions of dollars of additional revenue to meet its basic investment needs. The Safe Drinking Water Act now requires states to include an assessment of a utility's financial capacity in the permitting process. The situation in North Carolina is no different from the rest of the country. Statewide gap analyses have been completed in this state leading to equally frightening numbers. The purpose of this research is to begin addressing the question "How well prepared are North Carolina utilities for meeting the upcoming financial challenges facing them? by analyzing the best currently available data related to financial capacity and affordability.

Literature Analyzing Infrastructure Shortfalls

There is a substantial literature dealing with the analysis of infrastructure shortfalls in the various states; the states in the EPA's Region 4 are no exception to this trend. The Water Infrastructure Network (WIN) has released three separate reports dealing with the issue of infrastructure investment. The Clean & Safe Water For the 21st Century report, issued in April of 2000, addresses the big picture of infrastructure investment shortfalls - estimating that an annual $23 billion dollars is needed to overcome the projected difference between current infrastructure investments and the investments required annually to replace and maintain equipment (and comply with the federal Clean Water and Safe Drinking Water Acts).

WIN also estimates that if local revenues alone were to meet this projected increase in infrastructure investment by raising their rates, the resulting increase would double or triple consumer bills, surpassing their suggested affordability threshold of 4% of household income (allocated towards water and sewer expenditures). This of course only represents an average effect; many systems presumably would be on the higher end of the "average" and would have to make substantially higher rate increases than double or triple changes. In addition, there would be a feedback effect between consumers and service providers, as with any other interaction between a consumer and a monopolist - increasing price would cause a reduction in the firms' revenues at the same time due to consumers cutting back on their consumption of water and sewer services.

A third report in the series addressing the infrastructure shortfall by WIN estimates (based on a sample of 20 utilities nationwide) that from $550 to $2300 per household over 30 years may be needed to adequately repair and maintain existing equipment. The report, Reinvesting in Drinking Water Infrastructure, released in June of 2001, also stresses the importance of estimating the impacts of increased rates for consumers - as the report states, addressing affordability is the heart of the challenge.

The federal government has also addressed the issue of infrastructure investment and consumer affordability. The Congressional Budget Office, in its November 2002 report Future Investment in Drinking Water and Wastewater Infrastructure, reports that between the years 2000 and 2019, annual average costs are projected to range from $24.6 billion to $41.0 billion dollars (depending on the scenario selected) nationwide for infrastructure investment. The CBO study also estimates that household water bills will rise from 0.5% of a household's income to between 0.6 and 0.9% by the year 2019. The CBO report also tends to downplay the significance of the suggested affordability threshold of 4% of annual household income spent on water as a metric, pointing out that 4% carries no particular economic significance in relation to household affordability.

The EPA also prepared its own analysis of the projected gaps between infrastructure investment funds and needs; the September 2002 report projects estimates of gaps based on revenue increases as well as revenue staying steady. For clean water and drinking water respectively, the estimates range from between $31 and $271 billion dollars and between $45 and $263 billion dollars annually (depending on the revenue change estimate chosen).

Literature Analyzing Elasticity of Water

There is a substantial literature that deals with issues of consumer responsiveness to changes in water prices in economics. A report for the California Department of Water Resources by Mary Renwick, Richard Green, and Chester McCorkle, for example, calculates an elasticity estimate based on almost 25% of California's population. Their model estimates that for an increase in income of 10%, there is a corresponding increase in water demand of 2.5%, an estimate they report to be close to other estimates reported in the Water Resources Research Journal.

Literature Analyzing Infrastructure Capacity

There is a substantial literature generated by various water-related research entities dealing with the issue(s) of infrastructure shortfall studies. The Environmental Finance Center of Boise State University has issued several such "capacity assessment" reports. In the two reports issued by the Environmental Finance Center (one for the City of Jerome in Alaska, and the other for the City of Palmer in Ohio) the EFC follows a very structured analysis in their determination of creditworthiness for DWSRF funds (Drinking Water State Revolving Funds). As part of the application process for capitalization funds through the DWSRF's, states must conclude that systems seeking funds will be able to maintain compliance with the Safe Drinking Water Act (SDWA).

The Boise State University EFC analyzes two areas of assessment: fiscal capacity measurement and financial management assessment. In terms of our interests, the first part of the Boise State EFC, which addresses consumer affordability, is the most relevant. Both assessments of capacity assessment focus on three measures of affordability: (1) an affordability index relating approximate monthly utility cost and median household income; (2) a ratio of utility sales to utility receivables; and (3) a future affordability index calculation (which replaces the monthly current estimates of cost and income with projections of both). In addition to these three measures specifically targeted towards consumer affordability measurement, the Boise State assessments address general utility financial health by analyzing expenses and revenues, rate setting frequency, and additional sources of revenue to supplement any potential budgetary shortfall.

In addition to these reports modeling approaches to gauging affordability, there have been several published critiques of the EPA's use of 2.5% of MHI (median household income) as a metric for the affordability of water bills. Scott J. Rubin, from the National Rural Water Association, has published several such critiques arguing that a simple reliance on such cut-off measures ignores several aspects of affordability (such as inclusion of water bills in rental agreements, and the relative presence and absence of such inclusive arrangements over time).