Water-Financing Innovation Is Increasingly Local

WaterfallA trend toward decreased federal funding for water infrastructure in the United States is driving a search for innovation in financing to deliver services. Local authorities are using new conservation finance tools to address aging infrastructure and water delivery.

While these new financing mechanisms have not yet reached their desired levels of scale and repeatability, practitioners are hopeful that the success of closely watched pilot programs, such as DC Water’s green century bond, will drive further investment of private capital in the water sector.

The 2016 Aspen-Nicholas Water Forum, hosted by Aspen Institute and Nicholas Institute for Environmental Policy Solutions, showed the role of impact investing in bridging the financing gap in the water sector.

The resulting report, “Conservation Finance & Impact Investing for U.S. Water,” offers case studies and analyses of new tools and models that are taking root in the industry.

This Q&A with Martin Doyle, one of the authors of the report, dives into the realities of funding water infrastructure in the current political and economic environment.

Doyle is the director of the Water Policy Program at the Nicholas Institute for Environmental Policy Solutions. He is also a professor of river science and policy at Duke University’s Nicholas School of the Environment. 

CFN: There’s been a shift from federal responsibility to state responsibility for financing water. How is private capital increasingly used? How much of the burden will fall on state and local government?

Doyle: It’s important to remember that, with regard to water quality, the Clean Water Act put enormous requirements for wastewater treatment on both industry aand municipalities. But when they did that, they brought an inordinate quantity of public capital as well.

What has really changed since the 1990s has been – for lack of a better phrase – unfunded mandates. We have increased the regulatory requirements on industry and especially on municipalities, but those requirements have not come with financial capacity for municipalities to meet them.

The reasons there is this flow of capital are:

  1. increasing requirements and less federal funding behind them;
  2. most of the infrastructure of the United States was built before 1970, so a lot of the infrastructure here is at its operational capacity and needs to be replaced;
  3. there is a growing amount of private capital generally.

401K plans are private capital. What private capital needs is places to park really big chunks of money. And there’s no better place to absorb large amounts of capital than infrastructure.

CFN: Are there any initiatives for collaboration between private and public capital to mix the capital stack?

Doyle: Yes, there’s a lot of interest in it. What people are looking for is whether there is private capital rather than tax-exempt debt financing and municipal bonds. We are trying to get a sense of whether that is going to be a changing trajectory. Right now, I don’t think that will be the case.

The cost of capital is so cheap for municipal bonds that I don’t see why we would want to be doing that. There are a few loan-guarantee types of programs that the federal government and state governments have been doing as well. I think that’s probably where a lot of the emphasis will be shifted.

The easiest place for me to see public-private partnerships is in loan-guarantee programs for water infrastructure because the default rate is so low for water infrastructure that the government should be in the business of guaranteeing loans.

There are some arcane federal budgetary reasons that make that problematic at the federal level, but I think state governments could really start to get in on that. So one thing that I think the Trump administration is going to potentially take on is tackling some of these barriers to investing in infrastructure.

CFN: There has been some resistance to public-private partnerships in the water sector. Has the P3 model been successful?

Doyle: If you listen to the rhetoric, the P3 model will save the planet. Everything now is a public-private partnership of some kind. If you go to your local water utility, especially the big ones, the private sector is there sitting side by side with the public sector. Consultants do all kinds of stuff.

The [question] is not whether we will have public private partnerships, but which functions we are willing to allow to be privatized. The P3 models we are looking at are generally lease programs where the private sector comes in and brings private capital.

Usually, this is going to come to bear when the water system can’t get quick access to traditional sources of capital. People get really nervous – and, I think, rightfully so – about how are you going to determine the rates of return that are allowed.

There are two ways of looking at it. [One could say] the big bad private sector is upgrading the facility to a degree that is completely uncalled for, so they’re putting all this money in to charge more money. An alternative view of it – I don’t know if it’s right or wrong – is that the public sector has been underinvesting in its water infrastructure.

When the private sector comes in, it’s doing a necessary level of capitalization of the infrastructure. The rates that you end up paying to the private sector are more accurately reflecting the value of water.

I will say, [Konisky and Teodoro] did a study a few years ago where they compared compliance of public water companies with private water companies. The private water companies had dramatically lower rates of safe drinking water act violations compared to the public sector. They’re investing more money into the system compared to the public sector and they’re getting results that show that.

WaterfrontCFN: What are some of the conservation finance and impact investing tools that you have seen in the water utilities or water resources sectors?

Doyle: On the utility side, what we’ve talked about really covers the classic water/wastewater/municipal water side. The other big nut to crack is the irrigation infrastructure out west and public infrastructure: United States Army Corps of Engineers (CoE) levees, United States Bureau of Reclamation dams and canals, and [solutions] like that.

Out west on the water side, there are a lot of funds that are now being developed called “blue funds” or “blue bonds.” They’re raising private capital to deploy water investments. There has been a pretty significant growth in interest.

The second part of that is related to investing specifically in irrigation out west – either water rights or irrigation-related infrastructure and opportunities. Those are the main things that I worked on when I was at the Department of the Interior up until January. And then there’s the whole other side of the United States Bureau of Reclamation and CoE infrastructure. That is a very specific type of investment opportunity.

CFN: Are there any transactions in water markets that show promise of encouraging future private investment?

Doyle: There’s two: one that’s been done and one that I think will get done. The one that got done that is the groundbreaking, transformative transaction is the deal District of Columbia Water and Sewer Authority (DC Water) did with Calvert and Goldman Sachs, the first environmental impact bond. The big gamechanger out of that one was that they tied the environmental performance to the financial return.

The better the project did, the better the financial return was. The worse the project did environmentally, the worse the financial return was for the investors. On the municipal water side, that’s the game-changer.

On the western water side, there’s a project out in Yakima, Washington on a United States Bureau of Reclamation reservoir. That one is trying to bring private capital to build a pump station to increase the delivery of irrigation water for pretty high-value crops in eastern Washington –  vineyards, apples, hops, and crops like that.

The thing that’s really interesting about it is the people who are structuring the deal are trying to tie environmental performance to the operation of the pumping plant. There’s a way that you can use the water for salmon-spawning-stream benefits.

By tying environmental performance to it, they are hoping to attract environmentally interested capital. Basically, these would be impact investors who might be willing to do an environmental impact bond, do a performance-based contract, or provide concessionary capital because of the environmental benefits.

That’s one that a lot of people are watching, myself included. I’m really keen on it getting structured in an interesting way. It’s a beautiful area of the world. The two irrigation district managers who are doing it seem like versions of Mark Kim and George Hawkins (of DC Water). They’re local water managers who are about as creative and innovative as thinkers as I’ve seen in a long time.

Again, the big thinkers are the local scale right now.

Note: Conservation Finance Network has held events at Duke University.

To comment on this article, please post in our LinkedIn group. You may also contact us via Twitter.