Slow growth in new customer base coupled with water conservation efforts due to drought conditions are combining to create yet another challenging financial year for U.S. water service providers. This situation presents a quandary for water utilities – which are actively encouraging water conservation while at the same time struggling to service high fixed costs.
This dilemma is apparent with the results of Black & Veatch’s 2015 Strategic Directions: U.S. Water Industry report. Nearly 47 percent of respondents cited slow growth as the leading factor negatively affecting revenue during the past five years. New customers provide many water utilities with a steady stream of capital.
The continuing multiyear drought has impacted customer behavior and compounded revenue issues. Survey respondents cited declining consumption as the second-most pressing revenue issue, at 45.5 percent.
“Consumption declines have been brought on by the greater adoption of water and energy efficient appliances, the slow pace of the housing market and manufacturing process improvements that reduce water use,” said Ann Bui, Managing Director for Black & Veatch’s management consulting water practice. She said this trend manifests itself as falling revenue in volume-based pricing systems.
Drought Prompts Increased Costs
With water scarcity concerns in much of Texas and the Western United States, security of supply becomes an increasingly large factor in the financial resilience of a water utility. Bui noted that drought may actually cause an increase in operating costs for water utilities due to the challenges of obtaining and treating marginal sources of supply.
For example, desalinated ocean water, a recent component of California’s water costs, may add a significant increment of cost, given its high energy usage. Other water utilities are being forced to obtain supply from resources further afield as traditional sources restrict allocations.
Other California water utilities are being forced to purchase water from new suppliers – in this case, agricultural interests, at rates of $700 per acre-foot to replace sources that were previously obtained at a near zero cost basis, Bui said.
On the other side of the country, the slow growth rates are coupled with the ongoing urban exodus from major Northeast cities such as Detroit, Cleveland and Buffalo. This continues to plague utilities in the Northeast as their customer base shrinks, and those remaining struggle to pay increasing costs.
Understanding Financial Resilience
Declining revenue represents just one aspect of the overall financial resilience challenges facing water utilities. The percentage of water utilities reporting sufficient revenues covering all financial obligations shows marginal year-over-year improvement – 36 percent in 2015 versus 33 percent in 2014. Slight improvements are also seen across most categories measuring financial strength.
“However, the fact remains that slightly more than one-third of utilities indicate they can cover all of their costs from revenue alone, leaving a significant number of utilities that cannot,” Bui said. “This discrepancy demonstrates the instability of the overall U.S. water infrastructure system.”
Furthermore, about 55 percent of respondents indicated the need for annual rate increases of at least 5 percent or more annually for 10 years to fully cover funding, far outpacing the less the 2 percent inflation rate of the past few years. These respondents noted that deferred maintenance during the Great Recession now require them to play “catch up.”
“The frequency of water main breaks on both the East and West coasts of the United States is increasing,” Bui noted, “which also results in economic impacts to the community.”
Searching for Solutions
The most common solution for trying to stabilize revenues in times of unpredictable demand is to shift from highly variable use-based rates to a structure that recovers a greater percentage of fees through fixed costs, Bui said. While this can be a way to moderate cyclical utility finances, she acknowledged that any resulting increase in water rates may affect low-usage customers – such as fixed income and seniors – more dramatically.
“It is evident that the political process will play a role in addressing these gaps. Public entities must find a clear balance between customer affordability and financial viability,” Bui said. “This is critical to strengthening the financial resilience of water utilities as they plan for a range of future extreme weather events and the ongoing challenges of aging infrastructure.”
Published originally on Black & Veatch Solutions.
