Assessing Water system revenue risk: Considerations for market Analysts
Water utilities are on the brink of extraordinary investments to replace aging infrastructure— the Environmental Protection Agency estimates that by 2030, capital expenditures of more than $300 billion will be needed to safeguard drinking water. Yet this investment comes at a time when Americans’ water use habits are changing1—resulting in considerable uncertainty for water systems planning capital programs to replace or expand their assets.
At the heart of the issue is the inherent mismatch between the largely fixed cost structure of drinking water service providers and the highly variable revenues they receive, which depend largely on the amount of water their customers use. This volumetric pricing model worked well in the past, when per capita water usage in the United States was much higher and more predictable than it is today. But appliance standards, conservation programs and even the price of water have changed across the nation, precipitating declines in household use that have led to much more variable—and in many cases, unexpectedly reduced—revenue streams.
Now more than ever, utilities must enact intentional pricing structures that contribute to financial stability. Yet while pricing structures can be engineered to assure revenue stability even within a volatile or declining demand environment, real political resistance may prevent water systems from implementing technically feasible solutions. In most American communities, how water services are priced is a community decision, one that is subject to political processes. Political leaders must be responsive to community concerns about resource stewardship, affordability for low-income populations and economic competitiveness. The financial necessity of implementing rate adjustments to adequately recover costs and maintain financial targets is balanced with (and sometimes pitted against) these important community priorities.
For municipal bond investors, the vulnerability of water systems’ revenues to demand changes is a matter of credit risk. Yet the credit metrics used by most analysts in today’s market may not sufficiently assess revenue vulnerability for many utilities. These metrics, which may examine the proportion of sales from the system’s largest users, or benchmark the price of water services at a given level of volumetric use, do not help to illuminate how significant changes in use across a wider customer base—whether driven by technological change, weather, pricing sensitivity or policy implementation—may affect revenue sufficiency. To truly understand the revenue resilience of water systems’ pricing structures to demand downturns—whether ephemeral or persistent—analysts may need additional metrics. This report characterizes the challenges facing many utilities and identifies potential metrics that may be used by bond analysts, including credit rating agencies, bond insurers and credit assurance providers and buyers.
We offer an analysis of revenue risk using actual utility data in three states that are experiencing changing water use patterns: Colorado, North Carolina and Texas. As our analysis demonstrates, utilities with the same generic pricing structure can have widely variable exposure to revenue instability from changes in customer use. This analysis reinforces the need for a continued focus by market analysts on the pricing structures of utilities and the relationship of those practices to fiscal condition and public policy imperatives including conservation and affordability.
We invite bond analysts to consider this analysis and potentially incorporate these metrics or similar metrics into their own assessment frameworks. We also encourage water systems to continue to incorporate revenue vulnerability considerations and metrics into their fiscal planning and board education efforts to help safeguard the financial stability of their communities’ most critical infrastructure, for present and future generations.