Water Systems Must Change Their Financial Outlook. Here's Where To Start.

By Julia McCusker

Rural utilities face a slew of challenges, with aging infrastructure being among the most pressing.

In particular, water systems will need major upgrades along millions of lines of pipe. Some areas still rely on pipes from the 1800s,¹ and the American Society of Civil Engineers recently gave U.S. drinking water infrastructure a C-minus grade.² Historically, drinking water has received even lower scores for many consecutive years.¹

The problem with upgrading these systems isn’t necessarily skills- or materials-based. It’s about proper funding.

Water’s Funding Factors

Water system leaders have done their best with ever-tightening budgets; since its peak in 1977, federal funding for the water supply has dropped off by 77 percent.³ Even with effectively reduced funding available, most water and wastewater systems rely on federal dollars and borrow through the government to fund projects. They have grown used to borrowing 100 percent of the funds without a required down payment or money in the reserve to cover complications.

Even when projects and upgrades are funded through government grants and loans, the money is often slow to disperse. In the case of emergencies or natural disasters, it can take months or years for local organizations to receive aid.

This funding deficit is further compounded by expected inflation. For the past decade or so, the cost of treatment chemicals, pipe, labor, and other resources has been relatively flat. Although it’s good that most water providers have not yet felt the sting of inflation, that means the industry is headed for a difficult adjustment. Upgrades and projects are already starting to cost much more than they have in recent years.

In addition to all of these factors, water systems are facing the complicated decision to increase rates, which is necessary to repay financing. This is especially true in socioeconomically disadvantaged rural areas. Because water systems are supplying a basic need and many have not historically raised rates, they have been hesitant to do so. But as the need to replace infrastructure rises along with normal operating costs, it will become necessary.

Sustainably Facing The Oncoming Financial Gap

Gone are the days of just-in-time management. System managers have historically been able to successfully handle infrastructure costs by reacting to major events and using “Band-Aid” solutions to get by. However, managers will soon have no choice but to adopt a proactive approach regarding sustainable funding sources. Here are a few ways to get started:

1. Understand that incremental rate increases are necessary for ongoing maintenance.

In Jasper County, Missouri, some residents saw a 47 percent jump⁴ on their December 2019 water bills. The Jasper County Public Water Supply District No. 1 had to increase rates to cover ongoing maintenance and operations in addition to vital infrastructure updates. In a statement, the organization said: “The district operates not for profit and has neglected to increase rates adequately for several years. According to the district’s CPA, the board has not in the past made adequate increases to meet cost and inflation.”

In short, the residents faced a drastic rate hike because the water district had not increased rates over time. Many other water districts follow a similar strategy where they wait until the last minute to increase rates — even if projects have been underway for some time. This inconveniences not only water systems, but also the residents they serve.

It’s best to increase rates over the long term, and it’s even better to take inflation into account. To accommodate expected inflation, upgrade requirements, and rising operation costs, water systems should raise their rates by 2 to 3 percent yearly. This will ensure systems remain financially steady and do not fall behind.

2. Maintain rainy day funds in case of emergencies.

Incremental rate increases are a great place to start — but that’s certainly not the only factor that will make a difference. Water and wastewater systems also need to have funds set aside for unexpected (or even expected) emergencies.

Case in point: The Rome Water System serves a small rural community in the Mississippi Delta. In the months before COVID-19, it suffered a tornado and lightning strikes that left the town without power and damaged water pumps.⁵ With homes destroyed, roads closed, and no power, the water system had plenty to deal with. But the pandemic hit, leaving many people in the community unable to pay water bills — and the water system with half its normal monthly intake. It didn’t even have the baseline budget to fix issues caused by natural disasters.

In times of crisis, government funding is not necessarily quick; it can take up to a year or two for rural systems to receive much-needed relief. How can systems get by until the funds come in, then?

Put simply, rural water systems can’t always count on immediate government funding in case of an emergency. Instead, they need to have a rainy day fund that could cover the costs of replacing major equipment at a moment’s notice or several months of operating costs in case the community is hit by another crisis. You might get reimbursed later, but it takes time. If you don’t have just-in-case savings built up, start now.

3. Have a realistic idea of what you’ll need to borrow for larger projects.

Many rural water and wastewater systems haven’t received upgrades in decades. Even with increased rates and rainy day funds, systems will need more cash to cover critical updates. The problem, though, is that costs have drastically changed. If your books have an asset value of $1 million from a project completed 10 years ago, it might cost closer to $4 million today.

It would be ridiculous to expect rural water systems to cover the cost of major projects themselves. But how much should they really be borrowing? Will interest rates make it much more economical to pay for at least a portion in cash (similar to a down payment on a house)? The other major piece of the puzzle is repayment capacity. How much are the expected payments for the financing, how long will you be expected to make them, and how does that balance against your monthly earnings — in addition to other rising costs?

Many systems don’t have a robust yearly budget, let alone one that projects five to 10 years down the line. But if you know a project is in the forecast, why not plan ahead?

A five-year plan is probably the minimum most water systems should have. This should account for all upcoming major projects and operations (including the rainy day fund). Managers don’t have to put this together on their own; stakeholders such as engineers, state or national organizations, and circuit riders can help out. Even financial organizations can lend a hand.

Rural water systems won’t be able to wave a magic wand to deal with oncoming upgrades and rising costs. But if they don’t do something to plan, they’ll find themselves with their heads underwater before they notice the rising tides. There are plenty of ways to approach financial planning, but the key is to get started.

Julia McCusker is the regional vice president of water 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.

References

1. https://www.pewtrusts.org/en/trend/archive/spring-2019/how-development-of-americas-water-infrastructure-has-lurched-through-history
2. https://infrastructurereportcard.org/cat-item/drinking-water/
3. https://www.theguardian.com/us-news/2020/jun/23/millions-of-americans-cant-afford-water-bills-rise
4. https://www.koamnewsnow.com/jasper-county-pwsd-1-increases-bill-by-47-sends-statement-to-koam/
5. https://www.pewtrusts.org/en/research-and-analysis/blogs/stateline/2020/09/11/strained-rural-water-utilities-buckle-under-pandemic-pressure