Revenue Insurance for Water Utilities?

insurance-utilitiesWater services are the most expensive utilities to operate in terms of capital required per dollar of revenue, yet in the USA water is typically the lowest monthly utility bill.[1] With growing populations, aging infrastructures, and increasingly dramatic climate stresses (both drought and flooding), water utilities are in dire need of higher revenues.

Ironically, the success of efforts to encourage water conservation has put even greater pressure on water utility revenues: if a rate-payer consumes less water, the utility collects less revenues. In 2015, for example, it is estimated that California water utilities will lose $500-600 million in net revenue because of the state’s mandated restrictions on water usage in response to the extended drought. The problem is, however, that while about 80% of a water utility’s revenues are from water sales, about 80% of its expenses are fixed. [2] Revenue variability, therefore, has a direct and immediate impact on a utility’s ability to properly maintain – let alone improve — its operations and infrastructures.

There are a number of ways that water utilities typically respond to revenue gaps and variability:

  • They raise rates. Although the public will often be understanding about temporary surcharges due to dramatic situations such as drought or flooding, public utilities with elected boards are typically loathe to invoke consumer displeasure from higher water rates.
  • They restructure rates so that a higher component of the monthly water bill is for fixed expenses, while still maintaining an incentive for the rate-payer to reduce consumption.
  • Larger utilities set aside a reserve fund to deal with temporary revenue shortfalls. This tactic, however, is not usually feasible for smaller water utilities (which dominate the US water industry sector).
  • They try to attract private investment. Here, though, there is a Catch 22. Commercial financiers want financially sound organizations that deliver a service that customers value. Concerns about affordability-cost balance deter private investors and, at present, only 2% of commercial infrastructure finance is going to the water sector.[3]

Recently, though, we came across two suggested responses to the water utility revenue conundrum that could be paradigm-shifting for the industry. The first was a trend noted by Ian MacLeod, VP of Marketing at MasterMeter, that the revenue variability challenge is driving “…private water companies to increasingly transition from equity owners to highly efficient professional service organizations that provide turn-key management solutions to utilities.”[4] Although the context of Ian’s remarks was the private water sector, this structural shift towards scalable, bundled service platforms could be just as applicable for publicly owned water utilities.

The other potentially game-changing suggestion is making revenue insurance available to water utilities. Utilities would pay a monthly premium based on the risk they are prepared to take and if revenues fall below a certain threshold, they receive a cash payout.[2] Although the idea of “weather derivatives” and other hedging financial tools has been around for a while[5], there seems to be a growing recognition that its time has come. It will be very interesting to see if forward-looking financial institutions will embrace the plan and achieve the scale required by any insurance scheme in order to mitigate risk.

There is no single solution, no silver bullet. Ultimately the water sector’s revenue variability challenges will be met by an array of creative solutions — from rate restructuring, to the emergence of highly efficient and scalable service platforms, to revenue insurance. The more stable the revenues, the more attractive the water sector will be for the private investment that is essential for ensuring that future generations will be able to continue to take for granted their access to high quality water.

References

[1] Tapping Into Alternative Ways To Fund Innovative And Multi-Purpose Water Projects, Water in the West, February 2016
[2] Could Insurance Markets Help Water Utilities Respond to Drought? , January 20, 2016, Brett Walton, Circle of Blue
[3] What are the opportunities for innovative water financing solutions?, Richard MacGeorge, October 2015
[4] An Insider’s View of the US Water Industry, January 27, 2016
[5] Environmental Finance Center at the University of North Carolina, Chapel Hill and Ceres, Measuring & Mitigating Water Revenue Variability, July 2014

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