A widening investment gap in U.S. water infrastructure is reaching a breaking point as assets reach the end of their useful lives, encouraging municipalities to consider private sector participation. Municipal governments fund 90 percent of water infrastructure but have suffered from weak credit ratings and unsustainable rates in recent years. Since 1990, investment levels by local governments in water infrastructure have stalled while the population has grown by 24 percent.
The level of financing needed to restore and expand water infrastructure is immense. Legislative initiatives are in the pipeline to initiate a gradual uptick of investment and remove barriers to private financing, which may increase private water investment opportunities. For instance, pending the governors sign off, New Jerseys Water Infrastructure Protection Act will fast-track statewide privatization.
Current Landscape for Private Water Utilities
Approximately 100,000 privately-owned water systems serve nearly 50 million people in the United States. State regulations, local water resources, historical infrastructure build-out and real estate development trends shaped a hyper-fragmented market with many residential systems of less than 1,000 connections.
Twenty large-scale investor-owned utilities (IOUs) represent 67 percent of the privately- owned systems by number and serve approximately 32 million customers. These companies generate approximately $7 billion in annual operating revenue as regulated businesses. Five states California, Texas, New York, New Jersey and Pennsylvania make up the bulk of water IOU portfolios, along with a group of smaller, more privatization-friendly markets Delaware, Ohio, Connecticut and Arizona that have afforded strong positions to private players.
Within the IOU market, American Water leads the pack with nearly $3 billion in revenue and more than 3 million customers. United Water and Aqua America follow with more than 500,000 customers apiece. Merger and acquisition deal flow has been relatively constant amongst IOUs, with more than 170 deals in the past 10 years. A small set of large deals have led to major new market entrants, while a large set of smaller tuck in deals have redrawn service areas and consolidated positions for entrenched players. Notably, in September 2014, Algonquin Power & Utilities Corporation, through subsidiary Liberty Utilities, announced an agreement with Carlyle Infrastructure to purchase 100 percent of Park Water Co. shares for $327 million.
Slowing the growth of private investment in water systems in some cases are municipalities pushing back by reacquiring systems from IOUs. The City of Missoula, Mont., in April 2014, filed suit against Carlyle Group to transfer ownership of Mountain Water Co. to the municipal government, citing rate hikes and non-compliance with service obligations. In January 2015, Blue Mound, Texas, approved the purchase of its water system from Monarch Utilities at a cost of $5.9 million over 25 years.
Future of Private Investment in Water Utilities
Bluefield Research forecasts greater private participation within the water utilities sector prompted by the recent passage of the WRRDA water bill, proposals including fiscal incentives for private project bonds and an infrastructure bank, along with cuts to EPA funding. Expected upcoming municipal opportunities are drawing greater interest from foreign investor groups seeking market entry.
An alternative to IOU ownership of water assets, the P3 model is under consideration for implementation at the federal and municipal levels, encouraged by successful past deals such as Veolias 2013 win of a 30-year, $300 million concession contract for Rialto, Calif. In Arizona, Liberty Utilities and the Central Arizona Groundwater Replenishment District will build a reclaimed water recharge facility through a P3. The project will use treated wastewater to replenish the aquifer from which Liberty Utilities draws water to supply its 17,500 water customers.
Select states stand out in terms of attractiveness for private water players based on policies and recent activity. Pennsylvania and Texas have been considered particularly constructive regarding IOU participation. California and New Jersey have hosted recent P3 contracts promoted as examples for other municipalities and states to follow, though new deals are slow to emerge. Other hidden gems include South Carolina and Florida, where Metalmark Capitals sale of Ni America has put assets serving 33,000 customers on the block. As in any municipal water market, tapping into new private investment opportunities requires strong local relationships and knowledge of existing systems that gives incumbent players a major first mover advantage.
Erin Bonney Casey is an analyst in Bluefield Researchs Advanced Water Treatment & Desalination practice, specializing in water treatment and reuse for the municipal sector and industry verticals globally. She can be reached at 617.963.5105 or ebonney@bluefieldresearch.com.
