Realistically Planning to Spend Federal Infrastructure Money

money and magnifying glass
By Joe Crea

The bipartisan Infrastructure Investment and Jobs Act of 2021 (Bipartisan Infrastructure Law or Infrastructure Bill) promises to inject $1.5 trillion across the country to “rebuild America’s roads, bridges and rails, expand access to clean drinking water, ensure every American has access to high-speed internet, tackle the climate crisis, advance environmental justice, and invest in communities that have too often been left behind,” according to the Biden administration. Of this investment, $55 billion will be directed to improve access to clean water by increasing contributions to state revolving loan funds over the next five years, and a large portion of this funding will be awarded as principal forgiveness loans.

With this prospect of billions of dollars of new federal funding for water infrastructure, many utilities will be tempted to rapidly increase planned capital investments. A rapid acceleration in capital spending can be achieved by some utilities, particularly those with outsized consent decree, asset management, or other regulatory-driven needs. However, accelerating the pace of capital spending will be easier said than done for many utilities. It is important that utilities in the latter group understand the importance of realistic capital planning.

Unrealistic capital planning can lead to excessive rate increases and customer affordability concerns, even with the best intentions. Let’s explore the key components of utility rate development and how the Infrastructure Bill can be used reinforce sustainable fiscal management!

Water and wastewater utilities are typically established as enterprise funds that must be self-sufficient with revenue generated primarily through user rates and charges. Developing a financial plan involves identifying a balanced projection of system revenues and costs. A financial plan has several major inputs:

  • Operating and Maintenance (O&M) Expenses: The costs to operate a system include personnel costs, chemicals, utilities, materials and supplies, and other miscellaneous expenses. The current high-inflation environment applies upward pressure on current and future O&M costs.
  • Outstanding Debt Obligations: Money that has previously been borrowed to fund infrastructure investments must be repaid. These costs are usually known and highly predictable over a planning period.
  • Capital Financing Plan: Funding new capital investments can be achieved through various debt instruments (bonds, loans, etc.) or cash (existing reserves or current revenues). Some capital investments influence operating costs by increasing or reducing the cost of operating facilities.
  • Customer Growth: System revenues are highly dependent on the number of customer accounts and quantities of water consumed. Changes in customer characteristics can increase or decrease the level of future rate adjustments.

For many utilities, current rates and charges are sufficient to meet the existing operating and debt obligations in a financial plan, while capital improvement projects become the biggest driver of future rate increase needs. Increasing the pace of capital spending on water infrastructure is justified because it is well known that critical infrastructure has reached the end of its useful life for utilities across the country. Despite the need, spending millions of dollars on water and sewer projects is hard!

Unrealistic capital planning can lead to excessive rate increases and customer affordability concerns, even with the best intentions.

Consider an example of the Acme Utility which has an approved five-year rate forecast built around a capital improvement plan with $50 million annual spending. During the first year of the plan, two of the city’s five project managers decide to take jobs with a neighboring town and the ability to manage consultants and contractors is reduced 40 percent. Additionally, the city’s procurement office recently implemented a new process for awarding contracts that lengthens the period of time to execute a contract. Just when city staff gets comfortable with the new system and takes a project to bid, they learn that local contractors are at capacity given workforce and supply chain problems.

These are just a few examples of many issues that frequently arise and lead to project slowdowns and deferrals. At the end of the five-year period, Acme Utility has only spent $150 million of the approved $250 million for capital projects. Now, city council has asked the utility to explain why they have such high balances of cash reserves and if their rates are too high? This is not a comfortable situation for utilities.

According to a 2021 Water and Wastewater Rate Survey by AWWA and Raftelis, over the past 20 years, water and sewer rates have increased at twice the rate of inflation (measured by the consumer price index). Failing to fulfill the promise made to customers that rate increases are needed to support capital spending will increase attention on the utility, and not in a positive manner. Similarly, accruing large cash balances by not spending appropriated funds may weaken the utility’s credibility with elected officials or other city departments and make it difficult to get approval for continued spending requests. Projecting accelerated capital spending can also lead to a forecast of rate increases that continue to outpace wage growth and cause customer affordability concerns.

The water industry has spent decades being mostly unnoticed by its customers by providing excellent and reliable service at very low cost. Replacing the aging assets is a serious financial burden and exposes the breadth of system infrastructure to customers. The Infrastructure Bill will provide all utilities with an opportunity to access increased Federal funding for water and sewer improvements, some of which will not require repayment. Developing a capital improvements plan that is realistic about the timing and magnitude of investments that can be delivered will allow utilities to balance this funding opportunity with sustainable rate increases and increased public support.

Joe Crea

Joe Crea is a vice president in Raftelis’ Cincinnati office. His work focuses on helping municipal utilities manage the myriad financial and managerial efforts required to maintain sustainable and effective service delivery. With more than 10 years of experience in the utility industry, Crea has developed a thorough understanding of the opportunities and challenges facing water and wastewater utilities.

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