Funding Trends WIP

8/8/2019 Funding Trends WIP

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In the following report, we take a closer look at water and wastewater infrastructure

spending and its drivers. Specifically, we examine the origins of state and federal funding

for water and wastewater infrastructure projects, as well as historical water rates across the

United States and Europe.

Key Takeaways• CWSRF allotments (federal funding) are down (49.41%) since 2000 and (66.94%)

since peak funding in 1991.

• The American Recovery and Reinvestment Act of 2009 authorized $4B for the CWSRF

program and $2B for the DWSRF program in FY2010.

• Water rates are used to pay for 90% of waste/wastewater infrastructure, which we

believe to be unsustainable due to comparatively low water rates in the U.S., as

compared to Europe.

• U.S. water rates have room to move – average price in the U.S. is $3.37 per thousand

gallons, compared to over $10 in Europe.

•

While state tax revenues are down (11.7%), we don’t expect this to severely affectwater/wastewater infrastructure projects.

• Since 1957, annuak water/wastewater funding has increased, on average, 3.2%, with

peak annual increases of 8-14% for the ten years from 1971-80.

• As a percentage of total yearly federal infrastructure spending, funding for

water/wastewater systems has increased from 19.4% in1957 to 27% in 2004.

• Funding for water/wastewater infrastructure projects increased by, on average, 3%

during the recessionary periods from 1957-2001.

• Companies involved in water/wastewater transmission and distribution are poised

benefit from an EPA estimated 20-year need of $200.8B.

While problems with dilapidated water systems have been prevalent in recent years, the

U.S. is merely at the beginning of what we believe to be the rehabilitation and replacementphase of the water infrastructure cycle. Last year aliened there were 240,000 water main

breaks in the U.S., which resulted in six billion gallons of water lost per day. While funding

for water and wastewater infrastructure projects has been steadily growing the since the

late 70s, current funding levels are not sufficient to support the needs of a weathered water

infrastructure network in the United States. The EPA recently estimated that there is a

$534B gap between current water infrastructure spending and projected needs over the

next 20 years, or roughly $26B annually. This compares to a total $10-12B in annual water

supply spending over the past 10 years. While funding has indeed been depressed for many

years, we believe that through growing recognition of infrastructure troubles and in an

attempt to further stimulate the U.S. economy, significant water/wastewater funding

increases are forthcoming.

Origins of FundingFederal funding to aid state and local governments in meeting safety requirements andenvironmental laws was originally provided through the Clean Water Act of 1972 andthrough the Safe Drinking Water Act of 1974. From 1972 to FY2008, $85.8B has beenprovided to states through these programs, with each state being allocated funds based ona specific formula. Funds provided by these acts are used to finance state revolving fundprograms, through which states offer local communities interest free loans for waterinfrastructure projects.



Clean Water State Revolving Fund (CWSRF) The CWSRF first funded water infrastructure projects in 1988 and has provided $68B in loan

assistance through 2008. As of 2008, for every $1 that the federal government provides,

$2.41 has been provided in assistance. Through 2008, 98% of the cumulative funds allotted

have been committed to infrastructure projects. Indeed, we believe that states are eager to

spend all available funding and should continue to commit the majority of funds provided by

the revolving fund programs. Despite the seemingly overwhelming support of the

government, CWSRF allotments have actually fallen (67%) from peak funding in 1991 and

(49%) since 2000 - federal funding has moved in the opposite direction of water

infrastructure needs. The American Recovery and Reinvestment Act of 2009 (ARRA)

authorized $4B for the CWSRF program in FY2010. This seems to be a one-time jolt to the

state revolving fund program to help bolster the economy. Given the state of the federal

deficit, however, direct federal assistance may not be sustainable at these lofty levels going

forward.

Drinking Water State Revolving Fund (DWSRF)In 1996, Congress passed legislation which authorized the Drinking Water SRF program,

which appropriated $1.3B in FY97. While funding decreased (43%) the following fiscal yearand remained at those depressed levels from 1998-2009, ARRA authorized $2B for theDWSRF program in FY2010, a 141% increase over FY09 funding. As previously mentioned,this lofty level of assistance may not be sustainable going forward.

Historical CWSRF Allotments Historical DWSRF Allotments

-10

0%

10

20

30

40

50

$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

$4,500

D o a r s n M o n s

$0

$500

$1,000

$1,500

$2,000

$2,500

97 98 99 00 01 02 03 04 05 06 07 08 9E

D o a r s n M o n s



% Decline Since 2000 -49.41%

% Decline Since Peak ('91) -66.94%

CWSRF Allotments

Top Ten: CWSRF Funding by State (FY10E) Top Ten: DWSRF Funding by State (FY10E)

NY11.2%

CA7.3

OH5.7%

TX

IL4.6%

MI4.4%

NJ

4.1%

PA

4.0%

MA3.4%

FL

3.4% TX8.3%

FL4.5%

NY

IL4.1%

MI3.5%

PA3.4%

NC

3.4%

OH3.0%

AZ2.8%



Noticeable recipients of FY10E SRF funding include California, Pennsylvania and New Jersey –

states in which covered companies own and operate water/wastewater systems.

CWSRF and DWSRF – Unreliable and Unable to Shoulder the Infrastructure Burden The CWSRF and DWSRF programs were not intended to replace state, local and privatefunding of infrastructure projects, but rather act a supplement. Congress originally intended

to phase out the CWSRF in FY1994, but pressure to extend federal funding caused Congressto reauthorize the CWSRF indefinitely. Though federal assistance has been significant indollars amounts, it has clearly been sporadic and significantly less than the needed amountto restore our systems to full operational efficiency. Furthermore, a Congressional ResearchReport indicated that, on average, ratepayers currently pay about 90% of the total cost of their water and wastewater systems, with the federal government covering the remaining10%. We believe that this ratio is not sustainable and the federal government will probablyhave to foot a larger portion of the bill in the coming years.

The U.S. is similar to Europe (discussed below) in that rates are the primary source of funding for rehab and replacement. Rates in the U.S., however, are considerably less thanrates in Europe, which is a reason for federal funding programs. Given that the average ratein the U.S. is $3.37 per thousand gallons, whereas prices are upwards of $10 in Europe, it is

evident that rates alone are not sufficient to fund 90% of infrastructure needs. Furthermore,since 84% of all water systems and 98% of all wastewater systems are municipally owned,many of which charge less than the economic cost of operation, the federal governmentcannot expect rates to solely finance 90% of the growing infrastructure needs. Manymunicipalities are reluctant to increase rates substantially due to political reasons. Throughour lens, we believe the federal government will need to increase assistance in the comingyears to fill the void left between funds generated by rates and what actually needs to bespent. Another alternative, however, would be for smaller municipalities to sell off theirassets to a private water utility firm, which have the necessary resources to upgradeinfrastructure.

State and Municipal Budget Shortfalls – Worst in Recorded HistoryWe note that while state tax revenues have posted the largest decline since records were

first kept 46 years ago, an (11.7%) y/y decline, we do not expect this to adversely affectfunding for water/wastewater infrastructure projects. As mentioned, water/wastewaterprojects are funded almost entirely through the SRF programs, EPA grants and rates(water/wastewater system revenues), rather than state tax revenues. Indeed, given thestability of municipal water/wastewater system revenue streams, the SRF program providesa reliable form of funding which has not been affected by the deteriorating credit market.States are able to borrow funds well below market value – rates were 2.2% in 2008,compared to the market rate of 4.6% for a 20-year loan. It is quite evident that localpoliticians prefer to spend their limited budgets on roads, schools and parks, rather than theinvisible infrastructure below our feet, for which they will get little recognition.

EPA Grants

Alongside traditional SRF funding, in 1989 Congress began providing further assistance to

state and local governments by appropriating funds to the EPA, which would then be used to

fund specific projects. These grants need not be repaid to the federal government, with the

federal government providing 45-55% of the total funds required, with the respective local

government providing the rest. The EPA has provided $7.1B in funds through FY08, funding

3120 projects across the country. Total EPA funding is less than 8% of what has been offered

through the SRF programs and is barely more than combined CW/DW SRF funding in

FY2010E. While EPA funding provides a needed supplement, it is hardly enough to consider

it as a significant funding source. No projects grants were awarded in FY07, as Congress



was unable to enact appropriations before the start of the fiscal year. As seen in the charts

below, EPA grants can indeed be lumpy and sporadic and as such are not suitable to support

the growing need for infrastructure spending. Furthermore, funding is unpredictable and

sporadic and can thus negatively affect covered companies.

Water Protection and Reinvestment Trust Fund – Pending VoteRepresentative Earl Blumenauer (D-Ore), along with four co-sponsors, recently introduced

bipartisan legislation to develop a Water Trust Fund to fund America’s growing

water/wastewater infrastructure problems. Dubbed the “Water Protection and Reinvestment

Act” (H.R.3202), Rep. Blumenauer noted a recent CBO estimate that suggests the act could

generate at least $10B a year. These funds would be generated through numerous small

taxes applied to beverages (4%), pharmaceuticals (0.5%), flushable products (3%) and a

0.15% fee of corporate profits over $4M, thus providing a deficit-neutral alternative for

funding water infrastructure projects. We note that similar trust funds exist for both

highways ($30B/year) and airports ($10B/year).

The act proposes that 48% ($5B) be allocated to the CWSRF and 35% ($3.5B) be allocated to

the DRSRF. The remaining funds would be spend on security enhancements (0.5%), sewer

overflow control grants (5%), R&D (5%), climate change (1%) and training programs (0.2%).

We believe this to be a healthy alternative to rate increases, as it reduces the burden

ratepayers currently shoulder. H.R. 3202 was referred to the subcommittee on Energy and

Environment and voting has yet to be scheduled.

Historical EPA Grants Total EPA Projects per Year

-20

0%

200

400

600

800

100

120

$0

$100

$200

$300

$400

$500

$600

$700

$800

$900

8990919293949596979899000102030405060708

D o l l a r s i n M i l l i o n s

Total Grant Value % Chan e in Fundin

4 4 2 8 13 946

20 2142

2

143

244

339

491520

669

259

20

100

200

300

400

500

600

700

89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 0



Water vs. Highway

Annual spending on water/wastewater construction remains significantly less than spending

on highway and street projects. We make this comparison as Highway infrastructure is

heavily subsidized by the federal government and is possibly a model for what may happen

in the future for water infrastructure funding, given the legislation discussed above.

According to the Congressional Budget Office, the state and federal government share the

burden of highway construction, with states covering 55% of the projects cost and the

federal government covering the remaining 45%. As mentioned previously, 90% of the

funding for water/wastewater infrastructure improvement is covered through rates. Since

1993, revenue from state water supply and wastewater operations has been used almost

exclusively to fund expansion and upgrades, as seen in the correlations below. Revenue is

driven almost entirely by water volume sold and the rates charged for that water.

While in total dollar terms funding for water/wastewater infrastructure remains abysmal

compared to highway and street spending, the annual percentage increases in spending are

in line with each other. While some variations have occurred over the years, funding for

both types of projects has increased by approximately 6% annually.

Annual Value of Public Construction Put in Place US Public Construction Spending Index

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 0

D o l l a r s i n M i l l i o n s

Highway and Street Water and Sewage

75

95

115

135

155

175

195

215

235

255

93 94 95 96 97 98 99 00 01 02 03 04 05 06 0

Water & Sewage Highway and Street



Correlation (Water Supply Rev:Exp) 0.9920

Correlation (Sewage Rev:Exp) 0.9779

As seen in the charts above, annual infrastructure spending has risen considerably over the

years. While states do indeed shoulder much of the burden for their roads and water

systems, the federal government does try to ease the pain. Aside from considerable funding

increases in the late 70s and early 80s, federal funding of water/wastewater systems has

remained flattish. Since 1957, yearly water/wastewater spending has increased, on average,3.2% and since 1991 spending has increased 2.0%. In comparison, since 1957 yearly

highway spending has increased, on average, 1.9% and since 1991 spending has increased

2.1%. A notable increase in funding occurred in the 70s and 80s, when annual increases in

funding ranged from 8-14% for ten years (1971-80), compared to highway construction

funding which actually decreased upwards of (8%) during that same period. During that

time, spending on new construction surpassed O&M for the only time in our observed time

period, partially due to the Clean water Act of 1972, the Safe Drinking Water Act of 1974,

and other federal environmental legislation. The decrease in highway spending may be

attributed to the OPEC Oil Embargo, during which the price of oil reached $100/barrel (2008

dollars). This, in turn, resulted in lower gas receipts, which are used to fund the majority of

highway and street construction.

Annual State and Federal Infrastructure Spending Annual Infrastructure Spending

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

56 60 64 68 72 76 80 84 88 92 96 00

M i l l i o n s o f 2 0 0 6 D o l l a r s

Federal - Highways Federal - Water/Wastewater

State -Water/Wastewater State -Highway

0

20,000

40,000

60,000

80,000

100,000

120,000140,000

160,000

180,000

200,000

56 60 64 68 72 76 80 84 88 92 96 00


Total - Highway Total - Water/Wastewater



The federal government has slowly been increasing funding for water/wastewater systems,

as a percentage of total funding, whereas funding for highways has decreased from 63% in

1956 to 42% in 2004. In the same time period, as a percentage of total yearly federal

infrastructure spending, funding for water/wastewater systems has increased from 19.4% to

27% in 2004, the highest level during our observed time period.

Indeed, during the same time period, while new construction rose only minimally, O&M

spending has grown an average of 4% annually. We expect O&M spending and new

construction spending to increase in the coming years given the growing understanding and

acceptance that improvements are imperative; however, we lack the visibility to forecast

future growth in spending.

Water Infrastructure Spending – Safe Bet during Economic Downturns

There have been eight official recessions, excluding the current recession, since 1957.

Federal funding for water/wastewater infrastructure projects during the studied recessions

only decreased once, by (3.8%) in the July 1981–Nov 1982 recession. Otherwise, funding for

water/wastewater infrastructure projects increased by, on average, 3% during the studied

recessions, which is in line with average annual funding increases during non-recessionary

periods. Annual percentage changes in funding ranged from (3.8%) to 9.8%. Conversely,

annual funding for highway infrastructure projects decreased in four of the eight recessions

since 1957; however, the average annual increase was 0.8% during the studied recessions.

Annual percentage changes in funding ranged from (7.5%) to 11.2%.

% of Total Federal Infrastructure Spending Annual Capital and O&M Spending

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

56 60 64 68 72 76 80 84 88 92 96 00

Highways Mass Transit

Water Transportation Water Resources

Water / Wastewater

0

10,000

20,000

30,000

40,000

50,000

60,000

56 60 64 68 72 76 80 84 88 92 96 00


New Construction Operation and Maintenance



Annual % Increase/Decrease in Funding During Recessions (1957-2001)

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

57-58 60-61 69-70 73-75 80 81-82 90-91 20

Highway Water



Highway Water

57-58 11.2% 3.0%

60-61 -1.0% 4.9%69-70 -1.7% 2.8%

73-75 -4.1% 9.8%

80 4.5% 2.8%

81-82 -7.5% -3.8%

90-91 1.3% 2.8%

2001 4.0% 1.7%

Average 0.8% 3.0%

Annual Funding

Increases/Decreases during

Recession

Global Water Prices – U.S. Pricing Has Room to RiseWater rates are primarily dependent upon three factors: (1) the cost of pumping and

transportation, (2) total demand, and (3) water quality treatment. The Earth Policy Institute

reports that municipal water rates have increased 27% in the United States over the last five

years, compared to 32% in the United Kingdom and 58% in Canada. According to a study

done by Bagder Meter, Inc (BMI: NC), in the 50 largest U.S. cities, the average cost of water

is $3.37 per thousand gallons, whereas the price is upwards of $10 in Europe. Some cities in

the U.S. are similar to their European counterparts – Atlanta charges over $6 per thousand

gallons and Pittsburgh charges $8.18 per thousand gallons. We note, in order for ratepayers

to fund the estimated $25B annual infrastructure need over the next 20 years, rates would

have to roughly double across the country. The water industry is a “rising-cost” industry, in

which rates are currently growing at approximately twice the rate of inflation.

Water prices tend to be higher in Europe for numerous reasons, including the three drivers

mentioned above, but also because of the high level of privatization in Europe. Private

companies, many of which are regulated (ie: OFWAT in the UK), must charge higher rates in

order to (1) pay taxes, (2) earn a respectable ROE, and (3) private companies are more

adamant about updating its infrastructure network.

In most parts of the U.S. the daily water bill is not much more than $1 per day, which is

relatively low in comparison to other traditional utilities. This presents an opportunity for

water utilities to increase rates to pay for large infrastructure spending needs as large (but

gradual) percentage rate increases may not be opposed by paying customers. We presume

that rates will continue to increase, on average, across that nation in the coming years. If this proves to be correct, annual infrastructure spending on the state and local level should

rise, as well.



Need by Project Type and Companies Positioned to Benefit

A recent survey by the EPA found that total nationwide infrastructure need is $334.8 billion

for the 20-year period from January 2007 through December 2026. Project categoriesinclude transmission and distribution (60%), treatment (22%), storage (11%), and source

(6%).

Transmission and distribution rehab and replacement projects are the greatest area of need,

with over $200.8B in forecasted need through 2027. While underground mains go unseen, it

accounts for the majority of the water infrastructure network in the United States. This

segment includes the outright repair and replacement of mains, as well as such products as

valves, flow controls, backflow prevention devices and meters to record water consumption.

Cost of Water by Country (cents/m3)

0

50

100

150

200

250

300

350

C o s t o f W a t e r ( c e n t s / m

)



The treatment category is the second greatest area of need, with approximately $75.1B

forecasted over the next 20 years. The majority of projects in this category are regulatory

driven and unlike the others are actually mandated by law. Projects include the new

construction and rehabilitation of treatment facilities (filtration, disinfection), which includes

the growing desalination market and membrane technology markets.

Storage projects ($36.9B) primarily include the construction or rehabilitation of waterstorage tanks. The source category ($19.8B) entails projects related to the new construction

and rehabilitation of water intake structures, drilled wells and spring collectors.

Cost of Water by Country (cents/m3)

Transmissio

and Distributi

$200.80

Treatment

$75.10

Source

$19.80

Other

$2.30

Storage

$36.90TotalNational Nee

$334.8B



Company Ticker Description Mkt Cap

Ameron International

CorporationAMN

Supplies concrete cylinder pipe, prestressed concrete

cylinder pipe, steel pipe, and reinforced concrete pipe for

water transmission and waste water collection.

688.73M

Arch Chemicals Inc. ARJ

Manufactures and sells products and equipment for the

sanitization and treatment of residential and commercial

pool and spa water, drinking water, and water used in

industrial applications.

688.73M

Badger Meter BMIManufactures flow measurement and control products for

water utilities, industiral customers and municipalities.564.18M

Flowserve Corp. FLS

Designs, manufactures, and sells water safety and flow

control products for the water quality, water safety,

water flow control, and water conservation markets.

4.81B

Gorman-Rupp Co. GRCDesigns and manufactureres pumps and related fluid

control products worldwide.382.76M

Layne Christensen LAYNProvides construction services and related products to

the water infrastructure and mineral exploration markets. 484.91M

Mueller WaterProducts, Inc.

MWA

Manufacturers water infrastructure and flow control

products for use in water distribution networks and

facilities.

499.48M

Northwest Pipe Co. NWPX

Manufactures large-diameter, high-pressure steel

pipeline systems for use in drinking water infrastructure

applications.

321.17M

PICO Holdings Inc PICOOwns and develops water resources and water storage

operations in the southwestern United States.553.52M

Shaw Group SGREngineering, technology, construction, fabrication,

environmental, and industrial services.2.54B

URS Corp. URS

Engineering, construction, and technical services to the

power, infrastructure, Federal, and industrial and

commercial markets.

4.19B

Public U.S. Companies with Water Infrastructure Exposure

Conclusion

We believe that a windfall of funding for water/wastewater infrastructure projects is

forthcoming. Though we cannot predict when this may occur, we believe that such funding

will either come from gradual rate increases, federal government funding, or through the

Water Trust Fund.

Given the evidence, it is evident that the government has been unable to support the

monetary needs of water/wastewater infrastructure improvement projects. We believe the

federal government is keen on improving the nation’s infrastructure network, but simply

cannot carry the burden itself. Private water utilities, which currently only service 8.8% of

the U.S. population, are slowing being offered greater incentives and the freedom to financeinfrastructure improvement projects. While the transition from public to private has been

slow, we expect the trend toward consolidation and privatization to continue in the coming

years, due to high capex needs and fragmentation in the industry. Simultaneously, rates

should continue to rise and narrow the gap between U.S. rates and our European

counterparts, so that ratepayers can continue shoulder a portion of the burden.

Documents

Funding Trends WIP