Authored by: Sean McGinnis, Director, The Horinko Group
June 12, 2012
In April, The Horinko Group convened the first in its 2012 Executive Roundtable Salons to explore proven and conceptual public-private partnership (P3) models to finance the massive overhaul awaiting our nation’s aging water infrastructure. Moderator, G. Tracy Mehan, Principal with the Cadmus Group and former Assistant Administrator for U.S. EPA’s Office of Water framed the discussion stating, “This salon is intended to focus on attracting private capital to the water sector by way of “pure-play” P3 models, absent government assistance or subsidy programs.”
One such model gaining popularity and cited during the salon discussion is the use of a concession lease to convene the public entity that owns the water system, the private entity that operates and maintains/improves the system, and the private investment partner(s) with the capital necessary to construct or rehabilitate the facility. The duration of the lease is critical when seeking such large, upfront private investment. A long-term, 20-year plus lease mitigates risk and provides the necessary rate of return for private investors. However, the typical lease duration between the municipality and private service provider is 3-5 years, insufficient time for the initial capital investment cost to be spread over the long life of the assets. In both instances, facility operations and maintenance is returned to the public entity at the end of the concession lease. The extended lease also permits a steady, graduated scale of water rate increases, while allowing for operational efficiencies to be implemented. Such proactive improvements reduce the uncertainty tied to financing unexpected infrastructure failures by way of sharp rate hikes.
Taking a closer look at how this concession lease model has been effectively implemented within our nation’s water sector, the Santa Paula Wastewater Plant in Southern California is worth recognizing. Operating under a consent decree with a tight timeline, the public entity sought to transfer construction, operational, financial, and compliance risk to a private entity with access to capital and the ability to invest efficiently and effectively. The original facility, built in 1939, was replaced with an entirely new water recycling facility, resulting from a service agreement between the City of Santa Paula and the private entity responsible for designing, building, and operating the facility – all financed by the private entity through a 30-year concession lease. The lease incorporated a water rate sheet that was stable, transparent, easy to comprehend, and summarized on a single page. Furthermore, the new facility’s advanced water reuse capabilities create the opportunity for additional revenue by selling reclaimed water for irrigation, thermal power plant cooling, fracking, or other water-intensive practices.
Another model highlighted during the April Salon was the creation of a water infrastructure fund that could connect pension plan beneficiaries with the stable, predictable returns provided by water systems. Serving in my previous capacity as an International Credit Portfolio Manager at The Northern Trust Company, providing credit and risk management support to global investment funds, I believe this model is ripe for future discussion. Opportunities exist for the water sector to attract major investment dollars from a community of fund managers that are overseeing and managing massive pools of private capital. Thinking locally, public-service pension assets from teachers, firefighters, and police could be invested into water systems directly benefiting the communities in which they live. Considering each state has varying laws and regulatory environments, it may be more efficient to invest pension assets directly back into the state’s own infrastructure. By connecting the infrastructure investment back to the community, stakeholders will become better informed as to the overall need and take greater ownership over the improvements.
In May, I participated in EPA’s first Technology Market Summit held in partnership with American University. This effort brought together the private sector and government to create a cross-sector dialogue on private investment and business opportunities presented by environmental technologies.1 A worthwhile case study presented a P3 financing model involving a wastewater facility retrofitted to harness energy production through biogas cogeneration. The Philadelphia Water Department (PWD) entered into a partnership with Ameresco to design, build, and maintain the biogas-to-energy system. Bank of America financed and owns the facility that cost $47.5 million to construct. PWD entered into a 16-year lease agreement to provide ongoing operations, with the option to renew the contract, purchase the cogeneration system at fair market value, or terminate the arrangement outright.2 The partnership provided the municipality with an innovative, non-mission critical technology, absent the upfront capital commitment and associated risk. A major takeaway from this case study was that our nation’s groundwork of existing infrastructure is in place to expand renewable energy production in a way that is scalable, replicable, and economical.
This success story suggests that similar partnership opportunities may offer solutions to a broader range of water infrastructure challenges. For instance, the Army Corps of Engineers and Bureau of Reclamation both acknowledge the dilapidated state of our nation’s inland waterway infrastructure. A P3 arrangement could be used to privately finance the rehabilitation of a lock and dam, by way of retrofitting the structure with hydropower. Through the generation of hydropower electricity, the future revenue stream could attract the private capital necessary to replace and maintain the infrastructure. Such an arrangement would require a long-term lease (50-year plus) to recover costs and permit an attractive rate of return, as well as an insurance component to address the longevity of the contract and further disseminate risk. Based on past discussions I have had on this concept, one of the greatest challenges continues to be the lengthy permitting process (5-10 years) required to locate hydropower on such facilities. While such permitting ensures necessary operational and environmental assessments, a further streamlined process will be necessary for this model to be financially viable.
To conclude, P3 models present an expanding range of near-term opportunities for our nation’s aging water infrastructure to attract much needed private capital. Long-term commitments that are equitable and benefit all parties will be critical. Both the public and private sectors must continue to test old assumptions and embrace innovative financing models. Subsidized, low-cost capital has a place, but is not the silver bullet. Establishing a financial toolkit that remains accessible, flexible, and includes several alternative financing options will be necessary to overcome these challenges.