Copyright 2001 eMediaMillWorks, Inc.
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Federal Document Clearing House
Congressional Testimony
March 28, 2001, Wednesday
SECTION: CAPITOL HILL HEARING TESTIMONY
LENGTH: 8320 words
COMMITTEE:
HOUSE ENERGY AND COMMERCE
HEADLINE:
TESTIMONY SAFE DRINKING WATER
TESTIMONY-BY: JANICE
BEECHER
AFFILIATION: BEECHER POLICY RESEARCH, INC.
BODY: March 28, 2001 The House Committee On Energy
and Commerce W.J. Billy Tauzin, Chairman Subcommittee on Environment and
Hazardous Materials Hearing Drinking Water Needs and Infrastructure Ms. Janice
Beecher Director National Association of Water Companies Testimony on
Water Infrastructure Needs On Behalf of The H2O Coalition 1
Purpose Water and wastewater services are vital to the quality of life for
citizens across this country. Although estimates of the industries total
infrastructure needs lack precision, there is actually a considerable amount of
consensus that the water sector faces its most formidable challenge in terms of
replacing and upgrading the aged delivery infrastructure. The purpose of this
testimony is to provide some general reality checks in relation to the current
national debate over infrastructure funding. The purpose of the analysis is not
to critique any particular perspective, but rather to help inform the dialog on
these most important issues. The Infrastructure Funding Issue Why is
water infrastructure funding on the Policy agenda? The
infrastructure needs of the water and wastewater industries have recently taken
a prominent place on the policy agenda, even though this issue is not entirely
new. The industries are experiencing extraordinary increases in costs and
investment needs that are closely related to people and pipe demographics - that
is, historical patterns of urban development and the age and condition of the
physical plant in place. Today, new data, models, and other tools have improved
our understanding of this issue. The various stakeholders that recognize these
needs have reached a critical mass. Estimating Needs General agreement exists on
the physical condition of the nation s many local water and wastewater systems.
A recent report card issued by the American Society of Civil Engineers (ASCE)
assigned low grades to most of the nation s various infrastructure sectors,
including Ds for water and wastewater. In 1995, studies by the U.S. EPA
estimated that water industry assets totaled about $144 billion (Community Water
System Survey, inflation-adjusted to 1999), while the estimated 20-year
infrastructure need totaled about $151 billion (Needs Survey, inflation-adjusted
to 1999). USEPA has recently issued an updated 20-year needs estimate that also
is in the range of $151 billion. EPA s estimates focus on needs directly and
indirectly associated with Safe Drinking Water Act (SDWA) compliance. USEPA
found that more than half of the total infrastructure need is for transmission
and distribution system needs. About 25 percent of the total need is for water
treatment facilities. USEPA has also estimated the impact of infrastructure
costs on households served by systems of different sizes. These findings
demonstrate how scale economies are a key determinant of cost impacts. Smaller
water systems are disadvantaged in this regard, although the service populations
of small systems vary in their ability to support the cost of service. In 1998,
the American Water Works Association (AWWA) escalated total 20-year water needs
to $366, billion (inflation-adjusted to 1999), focusing in particular on
distribution system needs. Today, various groups have coalesced around a total
20-year needs estimate in the realm of $1 trillion for the water and wastewater
industries. The $1 trillion 20-year needs estimate for water and wastewater
systems has become a focal point for discussion. The $1 trillion estimate is
imprecise. Comprehensive, valid, and reliable technical and financial data on
the nation s water and wastewater systems is not readily available. A precise
needs estimate is not as important as recognizing the general need. Indeed,
devoting scarce analytical resources to estimating the need may not be
beneficial. The gap is the projected cumulative shortfall that will result if -
and only if - (1) the infrastructure need estimate is accurate and (2)
expenditures on infrastructure are not increased. In other words, the gap will
materialize only if no action is taken to close it. Understanding the
Infrastructure Monster Understanding the infrastructure monster is a challenge.
It is instructive to look back to earlier research on water utility costs.
Evidence from earlier studies suggests an awareness of rising costs and the role
of infrastructure replacement in the cost profile: S The Nation s Public Works:
Report on Water Supply (Wade Miller Associates, 1987) forecast annual needs for
the water industry in the range of $4.8 to 7.1 billion as follows: 37-49% for
deferred infrastructure maintenance/replacement; 39-55% for meeting demand
growth; and 8-13% for Safe Drinking Water Act (SDWA) regulatory compliance S
Meeting Water Utility Revenue Requirements (NRRI, 1993) found that In reality,
SDWA compliance costs may pale in comparison to costs associated with
infrastructure and demand growth needs. Some of the larger utility systems also
have been aware of the need to step-up the pace of infrastructure replacement.
Some of the investor-owned (private) water utilities have been particularly
active in this area. As an example, St. Louis County Water prepared detailed
assessment of its distribution system in 1994. According to the company: An
accelerated replacement program is needed now if we are to avoid excessive
customer reaction and a crisis response plan. . . S The Company s infrastructure
replacement program is unique because it does not involve the construction of
one extraordinary asset over a long construction cycle (e.g., a nuclear plant),
but a multitude of short-cycle construction projects which, taken as a whole,
are extraordinary in nature. . . S The Company believes it is critical and in
the public interest. . . to synchronize rate recovery with plant completion. (St
Louis County Water Company, 1994). Capital Intensity, Age, and Deferral The
water industry is very capital intensive, that is, physical plant or
infrastructure is a substantial core cost. Water investments also have very long
service lives that benefit generations of customers. Measured as a ratio of
utility plant to revenues generated, water utilities are more capital intensive
than the natural gas, electric, and telecommunications industries. Water
utilities must invest more than $3.50 for every dollar of annual revenues
received from customers. Trend data (and projected investments) indicate that
the water industry is becoming even more capital intensive. Industry experts
have estimated that pipes were installed in the early part of the century at a
cost of about $5 per foot (or less). It is not unusual for replacement costs to
total $100 per foot - which is more than double the overall rate of inflation
for the same period. The rate of replacement reflects the anticipated life
expectancy for a physical investment. A replacement rate of 1 percent implies a
life expectancy of 100 years. Lower rates imply a much longer - and unrealistic
- life expectancy. Today s pipe materials today are expected to last about 75
years, serving generations of customers. The rate of pipe breakage increases as
infrastructure ages. Breakages lose water, disrupt service, and pose public
health risks. Emergency repairs typically are much more costly than planned
repairs. The rate of breakage varies with pipe material, which also correlates
with the period of installation. Also, as facilities age, the overall percentage
of accounted-for water declines; that is, more water is lost. The value of water
losses has increased with the increased cost of water supplies, treatment, and
pumping. Following its assessment, St. Louis County proposed to pick up the pace
of replacement from 5 (.13%) to 30 (.8%) miles of pipe per year (total pipe
miles equal 3,882). But even the accelerated pace of replacement now used by
some systems is probably inadequate based on current knowledge about the life
expectancy of materials. But making the case for replacement needs to rate
regulators and other oversight bodies (mayors and city councils) has been a
significant challenge. Recently, some private utilities have won approval for
surcharge mechanisms to help fund a continuous program of replacement, while
also mitigating rate shock (the leading example is the Distribution System
Improvement Charge, implemented in Pennsylvania). Although much of the
infrastructure challenge is simply age- related, at least part of the current
need can be attributed to capital deferrals, or the postponement of
infrastructure investments. Because their profit is based on the value of their
rate base, investor-owned utilities have less incentive to defer capital
investments. Deferrals exacerbate the gap problem by increasing the level of
need and thereby widening the gap between future expenditure levels and current
revenue levels. A model developed by Australian researchers suggests that the
compound effect of infrastructure replacement needs over several decades
suggests a Nessie curve, named after the mythical Loch Ness monster. These cost
curves can provide a useful model to help utilities and other stakeholders
understand needs at the system level. In reality, the challenges of prudent
capital replacement and lumpy capacity are not new to utility economics. Other
utility sectors have faced - and are facing - infrastructure needs. However,
today s water and wastewater infrastructures were cheap to begin with, were
well-subsidized (particularly for wastewater), and have long been depreciated.
These factors combine to create an extraordinary pressure on costs. Emerging
information systems, planning and management tools, and alternative technologies
can help manage the monster - and close the funding gap. The real risk today may
be in the potential for a responsiveness gap, that is, the gap between awareness
and knowledge about an issue or problem and taking the actions necessary to
address the problem and avoid or mitigate deleterious effects. However, debate
is open as to how to respond to the challenges now faced by the water industry,
particularly with respect to private versus public responsibilities. The
Emerging Myths The infrastructure funding debate is contributing to a number of
emerging myths that may or may not be grounded in reality. The myths suggest:
That a national crisis is looming. That the cost of water services cannot be
supported through rates. That a funding gap is inevitable. That public (that is,
federal) funding solutions are essential. Some reality checks may help inform
the infrastructure funding debate by challenging some of the emerging myths.
These reality checks are offered not as criticism of any given perspective, but
rather to bring an empirical perspective to the dialog about these important
issues. Reality Check: Municipal Finances The water and wastewater industries
are dominated by municipal ownership. Care should be taken to not
over-generalize about municipal finances. However, some of the available data
(from the U.S. Census of Governments and elsewhere) may be relevant to the
funding debate. The data indicate that in general, when municipalities provide
electricity and natural gas services, revenues from user charges exceed
expenditures. For water and sewer services (as well as solid waste and transit
services), expenditures exceed revenues from user charges. The findings
generally suggest that municipal water customers do not cover expenditures
through rates. The implications of this gap are worse if the expenditures
understate the cost of water service (as is the case with deferrals). Of course,
individual water and wastewater systems may have very different financial
profiles. The deficit between expenditures and user charge revenues is
detectable for different types of publicly owned water systems: municipalities,
special districts, counties, and townships. Trend data indicate that the
expenditure-revenue gap has been persistent over time, although it has closed
somewhat. The difference between expenditures and revenues must be made up
through tax revenues and subsidies (grants). The trend data are comparable when
displayed on a per-capita basis. Data for individual cities show that aggregate
expenditures on water, energy, and transit utilities exceed user-fee revenues in
some cases, but not in others. Similar results can be seen for municipal
wastewater systems. For investor-owned water utilities, operating revenues are
provided primarily through cost-based rates charged to customers, and revenues
exceed expenditures. An investor-owned water utility must support the full cost
of service through rates in order to survive. The difference between revenues
and expenditures is used to pay for taxes, depreciation, and the cost of
capital. Rates charged by private water utilities are strictly regulated by
state public utility commissions, which adhere to accepted systems of accounts
and cost-of-service standards of ratemaking. USEPA data (Community Water Systems
Survey, 1995) also revealed that privately owned water systems collect more
revenues per gallon than publicly owned systems. Municipal debt can be used for
long-term capital investments, such as water treatment facilities. Debt
instruments that can be used by the water sector include traditional issuances,
as well as private-activity bonds. Debt instruments should not be used for
routine maintenance (considered an annual expense). However, debt (short-term
and long-term) can be used for major capital replacements to amortize costs over
time. Ideally, costs are recovered over the useful life of the capital
investment (although in practice shorter time periods are used). Several
interrelated financing issues have contributed to or complicated the
infrastructure funding problem. These factors include: unrealistic service-life
expectations, extraordinary cost inflation, inadequate accounting and accounting
standards, investment deferrals, inadequate user charges, profits and reserves
for a few systems, and concerns about rates and equity. Accounting standards are
the domain of the Governmental Accounting Standards Board (GASB) for
governmental utilities and the state public utility commissions for
investor-owned utilities. Reality Check: Household Expenditures Household
expenditures for utility services and other goods and services provide another
relevant perspective. Consumer expenditure data are available from the Consumer
Expenditure Survey (Bureau of Labor Statistics). Although the data have
limitations, they are useful for general purposes. Water and public services
(sewer and solid waste) account for a relatively small share of the average
household utility budget (less than .8% of total expenditures), particularly in
comparison to electricity (2.4%) and telecommunications (2.1%). In many
respects, water services are a bargain to average households. Of course,
averages mask relevant variations and actual expenditures are affected by many
factors. Over time, average household expenditures for utilities have climbed,
but expenditures for water and other public services have retained their
relative position. The percentage of household income and expenditures devoted
to utilities has declined with time, although the share for water and other
public services has remained relatively constant. On average, a four-person
household spends about the same amount each year on cable television and tobacco
products as on water services. Americans have shown a tremendous willingness to
pay for advanced communications and entertainment technologies, including
cellular phones ($41.24 per month), cable television ($28.92 per month), and
internet services ($21.95 per month). For many U.S. households, the expenditures
for these more discretionary services are greater than for water services. It is
noteworthy that the nation s $80 billion cellular telephony infrastructure has
been entirely supported by private providers who collect fees from users.
Reality Check: Global Comparison Another reality check can be made using
comparative international data. Americans use more water per capita overall than
most nations of the world. Yet water prices in the United States are
comparatively lower than prices charged by water service providers in many other
developed countries. These findings also are supported by a study conducted by
researchers in the Great Britain who controlled for international difference in
the gross domestic product. Reality Check: Rate Shock Large rate increases have
the potential to cause rate shock among customers. Technically, rate shock
applies when a rate increase is associated with a significant drop in usage,
which reflects the willingness (and ability) to pay for service. For essential
services (with relatively price-inelastic demand), these drops may be
transitory. The term rate shock is also used to describe the pubic outcry
associated with rate increases - which may have no basis in affordability.
However, the extent of rate shock and affordability concerns depends in part on
the level of the current water bill and the magnitude of the rate increase.
Techniques are available to mitigate rate shock and address genuine
affordability problems. Consumer Price Index data (BLS) reveal that real
(inflation- adjusted) water rates are rising faster than the overall rate of
inflation - along with prices for garbage collection, cable television, and
local telephone service. Data for individual communities suggest that real
(inflation-adjusted) rates have risen for some but declined for others. Any
given rate increase may or may not trigger rate shock or cause hardship. A
higher percentage increase on a low base may not be problematic for most
households. The magnitude of the increase relative to household income levels
should be considered. Public involvement and communications (including
informative bills) can help customers understand the reasons for the rate
increase. As suggested in the review of municipal finances, underpricing of
water services may be an important factor in the projected funding gap.
Underpricing sends inappropriate signals to customers about the value of water,
leading to inefficient useage. According to basic economic theory, underpricing
also leads to over-consumption and inefficient supply decisions to meet inflated
demand. Privately owned utilities are more likely to adhere to cost-based
ratemaking that recovers total revenue requirements (capital and operating
costs). Some communities deliberately maintain low prices for water and
wastewater services for reasons that include community values, economic
development, and political expedience. In some cases, rate increases have been
avoided for very long time periods. Taking inflation into effect, a stable rate
is actually a rate that has decreased over time. The loss of revenue presents an
opportunity cost to the community in terms of its ability to make appropriate
infrastructure investments. Rate shock in the water sector is possible because
rising costs must be recovered over flat per-capita demand. Affordability
concerns are real but manageable. Financing, ratemaking, and conservation
strategies can mitigate rate shock to a degree. Surcharge adjustments can be
used to achieve gradualism in rate increases. Larger systems can use
consolidated rates, progressive rate structures, and conservation targeted to
low-income households. Needs-based subsidies can be used to help eligible
customers by providing direct payment assistance or funding a lifeline rate.
From a theoretical standpoint, willingness to pay is represented by the demand
curve, which incorporates the consumer s ability to pay. From a practical
standpoint, ability to pay is a function of price and income and can be
addressed through rate design and subsidies (respectively). For many publicly
owned systems, the real problem is not the willingness nor the ability to pay -
but the willingness to charge customers at rates closer to the true value of
water service. Reality Check: Consumer Preferences Another gap seems to persist
between customer preferences and their willingness to pay for safe and reliable
water service. According to opinion polls (Gallup) Americans consistently
express a high degree of concern about drinking water and related issues.
Paradoxically, consumers do not necessarily appreciate the value of water
services. Consumers often appear unwilling to support rate increases necessary
to ensure drinking water quality and reliability. Indeed, low prices reinforce
the view that water services are an entitlement. Public education is needed to
close the gap between opinion and willingness to pay the cost for arguably the
most essential utility services. Water itself has no substitutes, but
alternative methods of delivery are available. For many U.S. households, the
price of one gallon of centrally-supplied water - conveniently delivered to the
tap - is less than one-third of one penny (see Raftelis Environmental Consulting
Rate Survey). In general, every other water alternative is no more safe, much
less convenient, and astronomically more expensive. At $1.15 per gallon, the
price of designer water is 347 times the price of tap water. Despite the high
costs, Americans continue to buy bottled water in increasing amounts. In 1999,
bottled water sales had increased by 12 percent. In 1999, the nation s water
utilities collected revenues totaling about $29.4 billion. Wastewater treatment
works collected revenues totaling about $26.3 billion. The bottled water
industry collected revenues totaling $5.2 billion. Rough estimates can be used
to compare the profit margin for bottled water versus tap water. For larger
bottlers, total production costs (including source costs) amount to about 10
cents for each bottle that can be sold for 70 cents or more (a 600% markup). The
markup for tap water, even for private companies, is closer to 10 percent.
Reality Check: Federal Funding The reality of the broader context of federal
funding also is relevant to any particular constituency, including the water and
wastewater industries. It is important for the water industries to have
realistic expectations about future federal funding for water programs in order
to plan sufficiently to meet infrastructure needs. Water services have always
been and always will be subsidized to a degree. Some subsidies are in the public
interest because of equity considerations, as well as health, safety, and
environmental protection concerns. All subsidies have distributional
consequences (that is, they result in both winners and losers). Subsidies can
also perpetuate dependence, inefficiency, and stagnation on the part of
recipients. Whether a water system or a customer, subsidies can mute incentives
for cost control. Subsidies require tax revenues and taxpayers are also
ratepayers (the same households pay one way or another). The social benefits of
subsidies should outweigh the total costs. Programs have been established to
assist low-income customers in other utility sectors. The LIHEAP programs
provide payment assistance for energy services. Under the 1996
Telecommunications Act, the Lifeline and Linkup programs provide assistance to
telephone customers. In reality, water and wastewater infrastructure funding
already exceeds federal funding provided to the LIHEAP and Lifeline/Linkup
programs. Levels of funding under the WIN (
Water Infrastructure
NOW) proposal would vastly exceed current levels for
water
infrastructure, as well as other utility programs. The WIN proposal
expands grant subsidies, which effectively can both reward and perpetuate
inefficiency. If a subsidy rewards past inefficiency, continued inefficiency on
the part of the system is assured because underpricing will persist.
Infrastructure funding for water is provided through the Clean Water and Safe
Drinking Water
State Revolving Funds (SRF). The principles
underlying the DWSRF are sound: demonstration of capacity by systems; priority
on pubic health and affordability; emphasis on loans (v. grants); and
ineligibility of maintenance and growth-related costs. The SRF should not reward
cost avoidance and inefficiency. The SRF should not advantage publicly owned
systems (and their customers) over privately owned systems (and their customers)
and further widen the gap in rates. Some programmatic reforms could enhance the
existing Clean Water and Drinking Water funding programs. Potential measures
include: improving efficiency and lowering administrative costs to states and
systems; addressing barriers to access and funding equity for different types of
systems (large and small systems; publicly and privately owned systems);
establishing fair criteria for funding infrastructure costs; and promoting sound
cost accounting and rate design The long-term federal funding environment for
all utility services is not without uncertainty. Concerns have emerged about
maintaining funding for telecommunications assistance programs under the Bush
administration. Base-level funding for LIHEAP (excluding supplemental
appropriations) has declined over the life of the program. The budget of the
USEPA also has been targeted for budget cuts under the Bush administration.
Reality Check: State and Local Priorities At the local level, water and
wastewater services - although vital to communities - are not always assigned
high priority. In many larger cities, funding needs for the water sector are
comparable to funding provided for professional sports stadiums. Given their
primacy for water and wastewater policies, the state also must play a role in
addressing the infrastructure issues. Several states have taken steps in this
area, including: Pennsylvania (cost recovery), Kentucky (regional
consolidation), Rhode Island (capital planning), Oregon (program integration),
and Texas (regulatory reform). Reality Check: The Gap The concept of a funding
gap merits further consideration and debate. The need to invest in the nation s
water and wastewater infrastructure is real, but the funding gap is essentially
a construct. The magnitude of the gap is uncertain and may be inflated. The
potential to lower costs through restructuring, innovation, operational
efficiency, and integrated resource management (including conservation achieved
by water-efficient fixtures and practices) may not be fully considered. The need
is largely attributable to system demographics (age and condition), although
some deferrals have probably exacerbated the problem. Many water utilities (and
most other utilities) can and do support the cost of service through rates. A
funding gap will materialize if deferrals and underpricing persist; that is, if
the responsiveness gap widens. The water industries must provide leadership and
effectively manage their current and future assets on the public s behalf.
Aggressive action is needed to close the projected gap from the top
(infrastructure needs) and from the bottom (expenditure levels). Cost-reduction
strategies for closing the gap from the top include: efficiency and optimization
(least-cost) approaches directed at both water production and usage; leadership
and continued technological innovation; and industry restructuring to achieve
scale economies and improve operational performance. Some gap estimates have
attempted to incorporate efficiency improvements - but a gap is still
anticipated. Technical and managerial innovation can substantially reduce
operating costs; capital costs can be reduced, but probably to a lesser degree
given the basic capital intensity of water services. Industry restructuring
includes consolidation and fundamental changes in system ownership and
management (including privatization). The gap can be closed from the bottom by
increasing revenues to support infrastructure expenditures. Revenue-enhancement
strategies include: cost-based (marginal-cost) rates to send better price
signals to customers, along with other ratemaking strategies (such as
surcharges); private-sector investment; and public-sector funding (local, state,
and federal). With the magnitude of the infrastructure need and the complexity
of the water sector, multiple revenue-enhancement solutions are necessary and
appropriate. However, cost-based rates should be emphasized and public subsidies
should be used judiciously. The public sector will continue to play a central
role in addressing water and wastewater infrastructure needs. The public sector
can: leverage other public and private funding sources; provide incentives for
optimal investment, operational efficiency, and cost-effective restructuring;
support research and development, data collection and information dissemination;
address at-risk systems and households based on demonstrable needs; and promote
sustainable water systems, not sustainable subsidies. The private sector can
play an expanded role in addressing water and wastewater infrastructure needs.
The private sector can: provide leadership, technical innovation, and research;
promote efficiency and sustainability through market-based solutions as
appropriate; develop a range of asset ownership and management options to
address capital and operating needs; secure and utilize available public
funding; and maintain accountability through regulation. The Real Challenges
Moving forward, the real challenges to all stakeholders in the water and
wastewater sectors may be to: Establish a new science of prudent asset
management for the water sector. Engage the public on water issues through open
and participatory processes. Demonstrate a willingness to charge for the true
cost of water service. Use public funding strategically to make lasting
improvements to operations. Do not postpone the inevitable and perpetuate the
responsiveness gap. Promote equity and sustainability over a long-term planning
horizon. Be receptive to technical and institutional innovation. Although
formidable, these challenges can be met. I look forward to working with this
Committee, the H2O Coalition, and all other stake holders on this issue. Thank
you for your attention.
LOAD-DATE: March 30, 2001,
Friday