Copyright 2001 eMediaMillWorks, Inc.
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Federal Document Clearing House
Congressional Testimony
March 27, 2001, Tuesday
SECTION: CAPITOL HILL HEARING TESTIMONY
LENGTH: 8414 words
COMMITTEE:
SENATE ENVIRONMENT AND PUBLIC WORKS
SUBCOMMITTEE: DRINKING WATER, FISHERIES AND WILDLIFE
HEADLINE: TESTIMONY WATER INFRASTRUCTURE
TESTIMONY-BY: JANICE A. BEECHER, PH.D
AFFILIATION: BEECHER POLICY RESEARCH, INC.
BODY: Testimony on
Water
Infrastructure Needs Presented Before The Subcommittee on Fisheries,
Wildlife, and Water Committee on Environment and Public Works United States
Senate By Janice A. Beecher, Ph.D. Beecher Policy Research, Inc On Behalf of The
H20 Coalition March 27,2001 Testimony by Janice A. Beecher, Ph.D. Beecher Policy
Research, Inc. 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 are 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: -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 -Meeting Water Utility Revenue Requirements (NRRI, 1993) found that
"hi 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. -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... -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 I 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 exceed
total capital and operating expenditures. For water and sewer services (as well
as solid waste and transit services), total expenditures exceed revenues. The
findings generally suggest that municipal water customers do not cover
expenditures through rates and other user charges. The implications of this
"gap" are worse if the reported 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 associated revenues is detectable for different types
of publicly owned water systems: municipalities, special districts, counties,
and townships. In 1997, for all local governments, the shortfall between
revenues and expenditures amounted to $4.18 billion for water services and $2.57
billion for sewer services (Census of Governments). 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 financial 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 actually declined
somewhat with time (during the period between 1984 and 1999), although the share
for water and other public services has increased slightly. 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 usage. 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 rate disparity (another "gap"). Some programmatic reforrns
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
(the "willingness to spend"). 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 regionalization and 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 H20 Coalition, and all other stake holders on
this issue. Thank you for your attention.
LOAD-DATE:
March 27, 2001, Tuesday