By Manju Chandrasekhar, vice president, ARCADIS
Six critical lessons are shared from a leading study on best practices for infrastructure investment.
To paraphrase the 2015 ARCADIS Sustainable Cities Index, there is no perfect, sustainable, utopian city. But that may not be the point. For populations around the world, the main question is: How are we going to deal with the hand we’ve been dealt? How will we manage to achieve the triple bottom line of social, environmental, and economic viability? Where do we start?
Considering the critical role of water across that triple bottom line, upgrading water infrastructure should be job one; yet in most communities, it’s not even close to the top priority. The reason? It’s easy to think the issue is money. But it may be more accurate to say that the problem lies in how the general public thinks about how water infrastructure is funded — or financed. In many cases, the population assumes that capital for water infrastructure comes only from public funding, grants, or endowments. The trouble is public sources aren’t keeping up with municipal water infrastructure needs. Communities where public funding falls short are facing some significant changes if they expect to enjoy a sustainable water supply.
Why? To start with, nationally the sheer enormity of the funding gap is so huge, it calls for new ideas. For several decades now, and through the economic downturn and its aftermath, communities across the U.S. held back on maintaining or upgrading water infrastructure, leaving the mountain of needed improvements even more difficult to climb. Estimates for the cost of repairing and updating U.S. drinking water infrastructure alone range from the U.S. EPA $500 billion projection by 2022, to the American Water Works Association’s (AWWA) estimate that the cost will top $1 trillion in the next 25 years.
Sustainable Options Will Take Work
With the stakes so high, U.S. utilities have two avenues to pay for needed infrastructure: 1) convince the public to pay for the true value of water and 2) embrace private financing strategies.
On the one hand, water systems that depend on ratepayers and taxpayers for operating revenue haven’t always elected to set rates in line with requirements to fund improvements. Those communities across the country now face a major hurdle: assessing what clean, safe, and efficient water supply and treatment are truly worth to the population, and demonstrating that value versus what ratepayers may be paying now. If funding is to come predominantly from public sources, planners will need to enhance users’ perceptions of the value of their water treatment and supply. Changing public attitudes can take years, even under inspired leadership. As we all know, this exercise also can pit competing interests against each other, further complicating the effort.
On the other hand, planners are not always fishing where the money is. Our public regulatory and institutional frameworks are not sufficiently well-structured to tap alternate capital pools, i.e., private financing sources. The Water Infrastructure Finance and Innovation Act (WIFIA) primed the pump, infusing much-needed public funding to catalyze private investment, but with first-year spending capped at $40 million, it’s clearly not the whole solution. The vision is that WIFIA credit assistance will generate $200 million in additional debt financing against private equity capital in the first year. Against a $500 billion need, it’s easy to see that more resources outside of the public sector need to be brought in.
A Fresh Eye On Private Financing Best Practices
Despite being the beacon of free-market practices, in the eyes of private capital providers and project developers, the U.S. has unfortunately not been able to develop a successful and long-standing track record of using private investment or public-private partnerships (PPPs) to finance water infrastructure. But that doesn’t mean the idea isn’t viable. Several countries outside the U.S., such as Canada and the U.K., have structured some good private financing models for infrastructure, including water projects, and we can benefit from their experience.
A study of infrastructure investment worldwide — the ARCADIS Global Infrastructure Investment Index — points to several ideas that could be adapted for the U.S. Here are some important lessons gleaned from the report that should facilitate in attracting both private and public investment:
Start Well To End Well: There’s no avoiding undertaking a thorough financial analysis to identify how to structure an offer — from using debt and traditional borrowing to equity investments by special-purpose vehicles combined with capital market instruments. As with any investment proposition, private investors are ultimately seeking stable, longterm, risk-adjusted returns in a business-friendly environment. But there are also risks that need to be addressed up front. To create opportunity for private funding, the right political, financial, and regulatory conditions also need to be present.
Connect Early On: Bringing all parties together to connect the built asset, the commercial issues, and the financial requirements up front should encompass the goal of achieving greater certainty of total lifecycle costs, both capital expenditures (CAPEX) and operating expenses (OPEX), across the investment program. For example, when the U.K.’s Thames Water Utilities Ltd. needed to achieve a step-change in delivery of its capital spending programs during a five-year regulatory period, the utility attracted and secured the best organizations and people in the industry ahead of the market and brought its input into the regulatory business plan submission early on.
Clarity Counts: Investors feel much more confident if the plan is clearly articulated, coupled with commitment to a defined program, timetable, and shortlists. The proposition should reduce uncertainty in every way possible, starting with a clear, accurate picture of the project’s risks and opportunities.
Put Risk Where It Belongs: Investors also respond more positively if they see risk has been spread appropriately and they are not expected to bear the entire burden. Assigning risks to the appropriate parties shows not only good faith, but good management. For instance, use public funding to put a project on firm ground during initial development. Public funding might help pay for lining up all environmental clearances beforehand or for initial plans and permits. In the long run, this distributed approach helps create stronger relationships with investors.
Spread ROI Across Asset Life Cycle: More and more, owners consider the total life cycle of their assets to create a more sustainable approach to return on investment (ROI) over time. This helps make the case that responsibly investing more up front can provide better long-term value for the project.
Resilience Matters: After learning the importance of flood resilience the hard way, cities hit by Hurricanes Katrina, Sandy, and others made sure that rebuilding specs included designs that anticipate future storms and floods. For example, ARCADIS helped the Bay Park Sewage Treatment Plant in Nassau County, NY, secure $810 million in funding from FEMA and the State of New York for repair and improvement.
As a result of these improvements, Nassau County will be able to pay for restoring the wastewater treatment facility damaged by Hurricane Sandy. But more importantly, since the county’s new state-of-the-art flood mitigation is designed to a 500-year storm level, its improved storm-resiliency aspects can engender a perception with private investors that their investments will be comparatively safer than those in competing projects that are yet to achieve similar resiliency protection. If the facility needs any work in the future, investment in resiliency would help put the project to the top of investors’ lists.
For many municipalities, bringing in private investment or creating public-private partnerships may be new, unknown territory. But look at it this way: Just as utilities are asking investors to see the promise of a project, public leaders need to have faith that the time invested in learning to tap new funding sources will pay off. Similarly, making the case to ratepayers and taxpayers isn’t that different. As stakeholders, they need to be convinced that they are getting return on their investment. Putting together the pitch with investment in mind will go a long way to creating a more sustainable program for financing water infrastructure.
About The Author
Manju Chandrasekhar is a vice president at ARCADIS in New York, where his responsibilities include leading business development and client-relationship management activities of the firm’s financial institution clients across the Americas. Manju leads ARCADIS’ efforts to establish itself in an advisory capacity at the executive level, with a focus on financiers, developers, owners, and operators of infrastructure and real estate assets.