Find The Right Rate To Fund Water Infrastructure Updates

By Michael Griffiths

Of course, every water system sets rates and discusses when, why, and to what extent they should increase. But here’s the problem: We don’t raise rates often enough — or high enough.

In my experience, water systems aren’t setting rates that are adequate enough to cover future capital expenditures. Every system needs repairs and maintenance, often unexpectedly and sometimes on a large scale. Every system will also need to replace critical infrastructure in the coming years. In some places, rates don’t bring in enough revenue to cover all those nonnegotiable costs.

Research from the American Water Works Association suggests that 29 percent of water systems struggle to implement pricing levels that cover their full costs.¹ With nearly one-third of the industry running at a revenue deficiency, that could put serious limits on how quickly or completely a water system can perform necessary repairs and urgent updates.

Ratesetting is a sensitive issue because rates have been increasing already. The average water and sewer bill rose by 3.6 percent in 50 cities in 2019 and has increased by 31 percent since 2012. In fact, prices for water have gone up faster than prices for gas and food and quicker than the rate of inflation.²

With this in mind, people are understandably sensitive to additional increases, and it’s difficult to raise rates on a necessary resource. In some cases, boards don’t want to make their neighbors mad or create an issue for their own communities. But steady, incremental increases are better than delayed increases followed by rate spikes. And given the amount of investment that will be necessary in the coming years, water systems shouldn’t be conservative about raising rates. On the contrary, they should see rate hikes for what they are: essential and overdue.

America’s Declining Water Infrastructure

The American Society of Civil Engineers gives America’s drinking water system a grade of C-³ and its wastewater infrastructure a D+.⁴ This is no surprise: Water runs through 2.2 million miles of pipes laid across the country,³ and many of those pipes are reaching the end of their intended lifespan.

We are already starting to see the effects of that aging infrastructure, and they provide a glimpse of the issues that many water systems will grapple with in coming years. The well-known water crisis in Flint, Michigan, is one such example. But there are other similar problems across the country. In Newark, NJ, elevated lead levels were found in the drinking water at multiple public schools and later throughout the municipal water supply. Newark resorted to giving residents bottled water and water filters in order to mitigate the contaminated water, but it’s still grappling with unsafe lead levels.⁵

Newark’s lead levels, along with the infamous Flint, Michigan, water crisis, are two of the most high-profile water crises in recent years. But they’re not the only ones, and they exemplify what happens when officials prioritize keeping rates low rather than funding necessary repairs and upgrades. Water systems will require major investments in coming years, and rates will need to be set high enough to fund those upgrades. Otherwise, the consequences could be catastrophic.

Smart Strategies For Ratesetting

Water systems must set rates high enough to cover future costs. However, they must also balance rates against the fact that water is an essential resource that’s become much more expensive in recent years. Ratesetting requires a careful calculus to satisfy all stakeholders. Start by applying these strategies:

1. Be transparent and objective.

Water systems are sometimes reluctant to raise rates for fear of attracting the ire of water consumers. Respecting the financial constraints of customers is important, but for the reasons outlined above, rate hikes are all but inevitable.

Soften the blow of these hikes by launching a campaign to educate customers on why increases are necessary and what the money will fund. Customers might take clean water for granted or not realize how much the water system costs to maintain. That means it’s vital to educate the public and explain the importance of water and the incredible amount of infrastructure it takes to bring clean water into homes and wastewater back out. Most people can accept paying more as long as the logic makes sense. To that end, have the state water association perform a rate study to identify the optimal figure. Associations often include this service with membership, and a rate increase justified by a study looks more palatable to the public.

2. Raise rates annually.

All water systems should raise rates annually — even those that currently cover their full costs. Small annual rate hikes acclimate consumers to paying slightly more for water every year, which reflects the reality of a water ecosystem made uncertain by climate change and water infrastructure overdue for major investments.

All water systems will need to increase revenue eventually, and waiting to increase rates only necessitates major year-over-year rate hikes that anger the public and encourage legal challenges. On the other hand, consistent rate hikes also allow a water system to create a pool of funding to cover unexpected expenses. That funding would have been incredibly helpful during the pandemic, when water revenues declined by up to 40 percent^{6, 7} in some places due to cratering consumption and unpaid bills. This is also important for the last point below.

3. Save for later.

Estimates suggest the U.S. water infrastructure needs $743 billion in updates over the next 20 years.⁸ There are plenty of projects to fund now, but water systems should keep at least 20 percent of their revenue in reserves for the upcoming future projects. The exact amount needed in reserves will vary by water system, but creating adequate reserves starts by establishing a capital improvement plan outlining the scope, timeline, and cost of ongoing repairs and upgrades. However much funding the plan requires at each stage dictates how much money should go into reserves. Knowing funding requirements also helps with future ratesetting.

More important than any single ratesetting strategy, water systems must avoid myopic thinking. It’s time to fund the future of America’s water infrastructure and start thinking about ratesetting with an eye toward the long term.

Michael Griffiths is the vice president of the Water and Community Facilities division at CoBank, a national cooperative bank serving vital industries across rural America by providing loans, leases, export financing, and other financial services in all 50 states. He holds a bachelor’s in management and a Master of Business Administration in finance from Northern Illinois University.

References

1. https://www.awwa.org/Portals/0/AWWA/ETS/Resources/2019_STATE OF THE WATER INDUSTRY_post.pdf
2. https://www.cbsnews.com/news/water-bills-rising-cost-of-water-creating-big-utility-bills-for-americans/
3. https://infrastructurereportcard.org/cat-item/drinking-water/
4. https://infrastructurereportcard.org/cat-item/wastewater/
5. https://theintercept.com/2020/03/15/newark-new-jersey-lead-water-crisis/
6. https://smartwatermagazine.com/news/nacwa/nacwa-estimates-us-water-utilities-could-lose-125-billion-covid-19-impact
7. https://csengineermag.com/covid-19-presents-a-complex-problem-for-water-providers/
8. https://bipartisanpolicy.org/blog/providing-critical-water-services-through-the-covid-19-crisis/