How Can We Finance Urban Water Challenges To Come: Do We Need A New Business Model?

As presented at International Water Association”s World Water Congress and Exhibition in Montreal, Canada

Tracy Mehan
Authored by: G. Tracy Mehan, III. Principal, The Cadmus Group

September 20, 2010

It is a pleasure to be here in Montreal to discuss new models for financing, in a sustainable way, our urban water systems to meet the triple bottom line of environmental, economic and social concerns.

My remarks today will address a broad array of issues which encompass entire watersheds as well as hard infrastructure itself. I hope to give you a North American perspective on these issues, both mine and others’, and conclude with some remarks on the recent report by the Aspen Institute which Patrick Cairo has also discussed this morning.

Today, there is increasing concern for protecting aquatic ecosystems as well as human health and the economy, greater attention to nonstructural as well as structural solutions, more emphasis on demand- side as well as supply-side management techniques. There is also a sharper focus on the entire watershed, catchment or basin-not just on discharges from the end of the pipe.

Currently, in the United States, our water and wastewater systems are not adequately supported by municipal politicians who, facing election every four years, are often disinclined to raise water rates to a level necessary to maintain their utilities’ infrastructure for its entire life cycle including replacement costs. Many water systems’ revenues are used to support more visible, labor-intensive activities such as fire and police services. By almost every measure available, the United States has the lowest water and wastewater rates of any developed, democratic nation in the world. No wonder there is so much angst about an infrastructure investment “gap” in our water sector, that is, the gap between required financing over time and the present rate of investment.

Recall that our colleagues from Amsterdam mentioned that the average household in their service area pays about 2 percent of its annual income for water and wastewater services. American households, on the other hand, are paying only 0.5-0.6 percent of income, on average, for water and sewer bills as calculated by the Congressional Budget Office (CBO).

While serving at the U.S. Environmental Protection Agency (EPA) in 2003, my colleagues and I proposed the Four Pillars of Sustainable Infrastructure which were: better management (including environmental management systems and asset management as pioneered in Australia and elsewhere), full-cost pricing, water efficiency and the watershed approach. This last pillar included source water protection, watershed-based permitting and water quality trading to meeting water quality standards, say, for nutrients.

If we were doing this exercise today, we would definitely include energy management as a fifth pillar.

The Four Pillars were important because they all contributed to a solid foundation of sustainable infrastructure and watershed management and encouraged least-cost approaches which generated multiple environmental benefits by focusing on more than just supply-side or traditional structural solutions.

Indeed, there was, and still is, a growing realization that traditional engineered approaches, alone, no longer meet our environmental, economic and social needs and wants. Indeed, the best and brightest of the engineering profession recognize the crucial role of an integrated, interdisciplinary approach which aims to protect the watershed as well as maintain hard infrastructure; adopts “green” practices which mimic nature; engages in robust civic education to communicate the importance of full-value, full-cost and conservation pricing; and begs, cajoles and often compels customers to use water-efficient fixtures and drought-resistant plantings.

“Water management has typically been approached as an engineering problem, rather than an economic one,” say Robert N. Stavins, a Kennedy School (Harvard) environmental economics professor, and Sheila M. Olmstead of Yale and Resources for the Future.

In their White Paper for the Massachusetts-based Pioneer Institute, Managing Water Demand: Price vs. Non-Price Conservation Programs (July 2007), they argue that water supply managers are “often reluctant to use price increases as water conservation tools, instead relying on non-price demand management techniques.” These would include actions such as requiring low-flow fixtures and restricting particular uses, which, while good things in and of themselves, are not as cost-effective as “using prices to manage water demand.”

Olmstead and Stavins review the literature on water pricing and the mysteries of price elasticity. Their conclusion? “On average, in the United States, a ten percent increase in the marginal price of water can be expected to diminish demand in the urban residential sector by about 3 to 4 percent,” say the authors of the White Paper. “Price elasticity of residential water demand is similar to that of residential electricity and gasoline demand in the United States.”

Olmstead and Stavins highlight a key limitation or drawback of non-price approaches. Water savings are usually smaller than expected due to “behavioral responses,” i.e., customers taking longer showers with low-flow shower heads, flush twice with low-flow toilets, or water lawns longer under day-of-the week or time-of-day restrictions. They cite a recent study of 12 American and Canadian cities which suggested that replacing two-day-per week outdoor watering restrictions with drought pricing could achieve the same level of aggregate water savings, “along with welfare gains of approximately $81 per household per summer drought.” Low-income customers can be helped through rebate programs “inversely related to household income, or some other measure.”

Water utilities are starting to consider increasing-block prices (IBPs) as part of their overall water conservation program. If nothing else, “it is better to have high prices on some consumption, than low prices on all consumption.” Stavins and Olmstead cite the case where a water supplier is concerned with reducing summer demand due to residential lawn-watering and sets the quantity threshold at which the price “jumps” at the “quantity of consumption generally achieved by households water lawns in the summer in that community.”

The movement away from an exclusive reliance on supply-side solutions and toward demand-side management techniques, such as pricing, non-pricing or hybrid programs (public education, too), is very desirable. Of course, they are not mutually exclusive and can work well in tandem. However, Canadian proponents of the “water soft path” (WSP) believe an even more radical approach is required, one that places ecosystem integrity at the heart of water management and governance.

In a stimulating and provocative volume, David B. Brooks3, Oliver M. Brandes and Stephen Gurman, editors of Making the Most of the Water We Have: The Soft Path Approach to Water Management (2009), tip their hats to American thought leaders, Amory Lovins of the Rocky Mountain Institute, and Peter H. Gleick, co-founder and president of the Pacific Institute, and a contributor to this volume, both of whom inspired the WSP. They assembled an interdisciplinary team to press their case that “the era of ‘endless’ freshwater is coming to an end” and “a 21st century approach to water management must move from a focus on large centralized reservoirs, higher capacity pumps and longer pipelines towards an emphasis on decentralized, smaller scale built infrastructure, alternative sources, such as rainwater collection, greater reliance on reuse and recycling, pricing and economic incentives and highly improved efficiency in water use, as the starting point.”

Brooks, et al. believe that cost-effective water savings of 20 to 40 percent are readily available, and several chapters explore a number of Canadian and other studies around the globe which they view as extremely promising.

The WSP is not simply a technocratic or value-neutral fix to a purely technical problem. A consistent theme in Making the Most of the Water We Have is that changing behavior or “social engineering” (an ominous phrase which actually appears in the text) requires a “value-laden” or “profoundly normative” political commitment to an ecosystem perspective over an anthropocentric view. In fact, “ecological sustainability is one of the WSP’s four controlling principles along with treating water as a service, not just a commodity (a view typical of most theories of sustainability); matching the quality of water to the appropriate use (not everything we want to do requires potable water); and planning from the future back to the present, so-called “backcasting,” an iterative process eschewing traditional planning which normally “starts from the present and projects forward to the future.”

In a rousing, even controversial call to arms, the editors of this volume assert, explicitly, that “Conventional cost-benefit analysis is not sufficient to ensure basic ecological resilience and ecosystem health.” Rather, “environmental constraints are built in from the start to limit the amount of water withdrawn from natural sources and to establish conditions on the quality of water returned to nature.”

Ergo: “Major inter-basin transfers of water are not considered acceptable; they contradict the objective of living with the water you have. Similarly, if there are water resources that are valued for their beauty or for their cultural or religious significance, they must be placed off limits for development.”

I think we can safely say that this is one of the provocative parts. Such an attitude on inter-basin transfers or diversions is probably popular on both sides of the border in the Great Lakes-St. Lawrence Basin; but it would be very unpopular, say, in California and other points west.

Professors Olmstead and Stavins, whose work I cited earlier, would be pleased with the emphasis on metering and “realistic water pricing” which these proponents of the WSP support wholeheartedly. Susan Holtz of the Canadian Institute of Environmental Law and Policy, and a contributor to Making the Most of the Water We Have, even utters the politically incorrect and self-evidently true statement that “the rhetoric of activist campaigns for water as a human right, and against privatizing water treatment, may encourage an attitude of entitlement toward water use and hostility to putting any price on it- making matters worse.”

As Patrick Cairo mentioned, I, too, had the privilege of participating in a process organized by the Aspen Institute to investigate a new model for sustainable water infrastructure management. Along with Pat and I, Michael Deane, president of the National Association of Water Companies (in attendance today), and incoming International Water Association president, Glen Diagger, also joined in this extended conversation in the beautiful surroundings of the Colorado Rockies.

The report of the Aspen Institute’s Dialogue on Sustainable Water Infrastructure in the US, Sustainable Water Systems: Step One-Reducing The Nation’s Infrastructure Challenge (2009), is very much concerned with discerning a “Sustainable Path” for the management of existing and future “hard” infrastructure, and setting out three principles, ten recommendations and twenty steps. It advocates “that the traditional definition of water infrastructure must evolve to embrace a broader, more holistic definition of sustainable water infrastructure that includes both traditional man-made water and wastewater infrastructure and natural watershed systems.” Besides tending to the concerns of physical structures, “a sustainable water infrastructure integrates these traditional components with the protection and restoration of natural ecosystems, conservation and efficiency, reuse and reclamation, and the active incorporation of new decentralized technologies, green infrastructure and low-impact development to ensure the reliability and resilience of our water resources.”

The Aspen Institute Report argues for an inclusive definition of infrastructure which encompasses “rivers, lakes, streams, groundwater aquifers, floodplains, floodways, wetlands, and the watersheds that serve or are affected by water and wastewater systems.”

I should mention that the Aspen committee tried to strike a realistic note, neither too optimistic nor too much “gloom and doom.” The following statement from the report typifies the prevailing attitude amongst the committee members:

“We submit that a crisis-driven approach, based on the ‘investment-gap’ analysis, will be insufficient to meet the growing challenges facing the nation’s water infrastructure. Rather than looking ahead with apprehension, a new framework that looks ahead with intention, by reframing the issue from one focused solely on an ‘infrastructure gap’ towards a more sustainable model or approach to funding water and wastewater infrastructure, is needed.”

Aspen’s redefinition is a movement toward a much more holistic view of the water delivery system in the U.S.

As water utilities and government entities around the country look at improving, upgrading, and replacing hard structures and built infrastructure, the report urges them to recognize the protection and restoration of the natural watershed as a critical way to improve water delivery in this nation. It encourages them to utilize emerging small-scale water technologies and management solutions that conserve water and energy on both the treatment side and the consumer side.

It also asks national leaders to consider the natural water cycle when considering water infrastructure costs and improvements. Thinking about the way water moves through plants and soil and air, as opposed to gutters and drains and concrete, and, in turn, adopting green and low-impact development techniques such as urban reforestation programs and green-roof and rain-garden projects, can ensure reliability and resilience of our water resources.

Utility and system managers, governing boards, and regulators must also ensure that the price of water services fairly reflects their full value to human health and the environment and recovers the cost of maintaining, operating and replacing this invaluable infrastructure. And they must address the needs of low-income customers through equitable rate design and, where necessary, direct subsidies.

Small systems present a unique challenge for federal and state agencies. Of the approximately 52,000 community water suppliers in America, 8 percent serve 82 percent of our population. Smaller entities should consider low-cost loans, consolidation, regionalization, and centralized financial and management systems.

The Aspen panel also views the federal government’s role as making strategic investments in new green and low-impact development approaches; water and energy efficiency; climate change adaptation; assistance to low-income or distressed customers; and research, development, and demonstration projects for integrated watershed management.

The message, at least from many circles in North American and elsewhere is that new tools and interdisciplinary approaches, on the demand-side as much as the supply-side, as well as recourse to non-structural as well as structural techniques, are all necessary to achieve a new model of managing water resources and its supporting infrastructure. Moreover, it is necessary to encompass the entire watershed and “nature’s services” and those techniques which mimic natural functions to achieve optimal results. Finally, we must recognize the full value of water as well as water and wastewater services in the prices we pay while supporting those whom financial hardship makes it difficult to bear those costs.

Thank you for allowing me to share these thoughts with you today.

G. Tracy Mehan, III is Principal at The Cadmus Group, Inc. (www.cadmusgroup.com) and former Assistant Administrator for Water at the U.S. Environmental Protection Agency, 2001-2003. Mehan may be e-mailed by clicking here.

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