How to Achieve a Sustainable Capital Reinvestment Rate in Four Simple Steps

Water services managers struggle between the need to generate sufficient revenue to maintain complex water systems and the need to convince both elected officials and residents that those revenue needs are warranted.”

“Our revenues are barely enough to keep the taps running, let alone fund pipe replacement.”

It’s the message I hear from municipal water managers almost every day. A sustainable capital reinvestment rate for water and wastewater systems — the amount of revenue required to maintain and replace infrastructure — remains a pipe dream (sorry, pun intended) for many small and medium-sized communities. Achieving financial sustainability is a goal that requires forecasting annual infrastructure maintenance costs, budgeting for future improvements, and creating a long-term strategy for building the capital required for both. And on top of all that, the impact of today’s decisions on tomorrow’s generations must be part of the equation.

Water services managers struggle between the need to generate sufficient revenue to maintain complex water systems and the need to convince both elected officials and residents that those revenue needs are warranted. If they undercharge, revenue shortfalls become the norm, ultimately leading to deteriorating infrastructure. But if they’re perceived to be overcharging, they can face community and political backlash.

Many communities commonly rely on simple depreciation as a guideline to project needs for asset renewal. However, this method is flawed in that it’s based on historical costs, so it doesn’t necessarily reflect future replacement costs. If you lean on this metric too heavily you’ll inevitably face a constantly increasing infrastructure deficit, which in turn leads to a growing political problem.

So how do you know how much you need to budget for renewal?

In our experience, we’ve found that simplifying long-term asset renewal funding can often boil down to formulating a new approach to communicating both costs and revenue requirements. It’s about telling better stories that are easier for elected officials and residents to understand. But in order to support those better stories, communities need to get the math right first. We’ve worked with many communities across North America to implement a straightforward method for developing a deeper understanding of the capital reinvestment rate they should be striving for. It’s one that’s very easy to explain, leading to greater transparency and understanding among both elected officials and ratepayers.

Here’s how it works, in four simple steps.

1. Calculate Long-Term Costs

We start with what we call the ‘Annual Cost of Sustainable Ownership’ (ACSO), which is the rate, in today’s dollars, required to cover the average annual rehabilitation and replacement cost of your system assets over the long-term, typically over the next 100 years.

This asset replacement schedule is calculated based on a reasonably easy to compile asset inventory, consisting of a listing of all assets, organized by category (i.e. meters, pump station, treatment plant, hydrants, etc.) including:

  • the year each was put into service;
  • the estimated service life of each;
  • a reasonable estimation of replacement cost (in the case of pipe, Waterworth can easily generate this for you based on material, diameter, and length).

We use this information to calculate a 100 year projection of asset renewal expenditures, then divide the total by 100 to arrive at the average annual cost.

Broken concrete pipes
2. Calculate Revenue Contributions

The next step is to determine how much money the water utility is currently investing in asset renewal and/or setting aside as reserve funds — we call this amount the ‘Annual Contribution for Asset Renewal’ (ACFAR). If a community’s ACFAR contribution consistently equals their ACSO, they will be in a good position to fund water services sustainably over the long term. In years where their ACFAR contribution exceeds their ACSO, that amount is placed into a reserve fund for future use, i.e. during years where expenditures exceed revenue. That reserve fund, combined with borrowing, acts as a buffer to keep water rates relatively stable over time.

Communities who currently use depreciation as their guide will all too often find that their ACFAR is well below ACSO — a sure-fire recipe for that infrastructure deficit mentioned earlier.

So for water utilities in that situation the next step is to:

 

3. Plan to Increase ACFAR to Equal ACSO

It’s never easy or fun to increase water rates but it’s often unavoidable if fiscal sustainability is the goal. We recommend gradually and incrementally increasing rates to reach your ACSO goal, which means reviewing them more frequently than you may be used to. It’s important to fine-tune your analysis annually, at least initially, to come up with the most efficient cost estimates for residents. And this process doesn’t have to be painful — tools like Waterworth can make the analysis easier.

Of course, borrowing to finance capital projects is a reality for many communities and debt does have a role to play. Waiting until reserve funds are sufficient to fully fund a project simply isn’t always feasible in the real world. Waterworth can help you factor borrowing and the cost of debt servicing into your long-term analysis.

 

4. Communicate 

A key component of reaching a sustainable capital reinvestment rate is getting buy-in from stakeholders, including elected officials, residents, and community groups. And that requires a solid communication plan.

It’s extremely important to build communications into the process, in a way that clearly explains both the costs and the benefits of fiscal sustainability. Doing so will provide stakeholders with a deeper understanding of the long-term revenue needs of their community’s water system and how water rates contribute to meeting those needs. That understanding will reinforce the importance of continuous reinvestment in the community to ensure water services remain healthy and sustainable, now and well into the future.

In 2016, a Black and Veatch study found that over two-thirds of North American communities are unable to meet their long-term water system needs with existing revenue levels. I hear the same from customers all the time and it’s one of the key reasons communities sign on with Waterworth. But if those communities embrace fiscal sustainability and implement strategies to achieve it, the result will be not only rate stability for residents and revenue stability for water managers, but also reliable water systems built on dependable infrastructure. That’s how the pipe dream of long-term sustainability can become a reality.  

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