Viewpoint: Knock down barriers to private investment in water infrastructure

By Van P. Hilderbrand and Lyndsey Bechtel

As the nation’s outdated water infrastructure deteriorates, the pressure exerted upon it by growing populations continues to increase. The Environmental Protection Agency estimates that by 2019, the capital needed for clean water and drinking water infrastructure improvements will approach $388 billion and $274 billion, respectively. Without immediate action, the United States will be unable to sustain its economic growth while still preserving the environment and protecting human health.

Although many local governments realize the need for improvements, they face budget constraints. Traditionally, to meet their needs, governments have relied on state and federal grant programs, state revolving funds, tax revenues and rate payments. However, the Congressional Budget Office recently concluded that “current funding from all levels of government and current revenues generated from ratepayers will not be sufficient to meet the nation’s future demand for water infrastructure.” Thus, more frequently governments are turning to private financing methods, including private activity bonds and private partnerships, but they are finding a limited number of willing partners — a situation that could change with federal help.

Financing through private activity bonds

A traditional financing vehicle for infrastructure construction and maintenance projects is private bond financing. In the United States, a local government can issue tax-exempt private activity bonds to private investors to raise capital. The governments slowly pay back the bondholders with proceeds generated by the projects. The bonds are attractive to private investors because there is low risk that the borrowing government will be unable to pay off the bonds with revenues from ratepayers and taxes. However, the increasing problem of water scarcity may add risk to even these traditionally safe investments.

Nonetheless, private activity bonds are the most easily adaptable method of private financing in the United States. The main drawback is that current statutory capital expenditure limitations prevent local governments from acquiring enough capital. A measure that would have eliminated the current caps was added to the surface transportation reauthorization bill, known as the Moving Ahead for Progress in the 21^st Century (MAP-21) Act. However, in July 2012, President Obama signed the bill into law without the provision.

Financing and operational improvement through privatization

Privatization is an arrangement under which private companies participate in the finance, design, construction, ownership, or operation of public facilities or services. The arrangements relieve the burden on governments to make direct capital expenditures to maintain or construct necessary infrastructure. Privatization exposes private investors and operators to a substantial degree of risk, including long amortization periods, changes in demand for water services, changes in government regulation, weather patterns or security requirements.

Despite those risks, privatization has been accepted in other countries. In the U.S., however, those risks coupled with several unique hurdles have kept private ownership and operation of water facilities to only 15 percent. First, public opinion and policy traditionally have resisted a shift in ownership and operation of water services from public agencies to private entities. Next, the absolute cost, scale and complexity involved in addressing crumbling water infrastructure are daunting. Finally, the current regulatory framework creates uncertainty and does not effectively motivate private companies to make the initial investments.  

To overcome those barriers, most successful privatization programs in U.S. markets are in the form of public-private partnerships. Such partnerships entail a contractual agreement between a public agency and a private sector entity to use the skills and assets of each to effectively and efficiently deliver a service to the general public. For example, private sector involvement may offer immediate savings by addressing inefficiencies through the implementation of best management practices. In such pragmatic solutions, each party to the agreement shares in the potential risks and rewards inherent in the delivery of the service.

Motivating private industry involvement

To create a space for greater private sector involvement in sustainable water infrastructure, the federal government should first revise the Internal Revenue Code to remove the current caps on capital expenditures by local governments. Second, it must encourage operating efficiencies by offering public-private partnerships tax credits and other special tax treatment. Finally, it should streamline potentially burdensome regulatory permitting processes. With those incentives, private industry may be able to justify the significant investment required to bring the nation’s aging water infrastructure to a point where it can adequately meet future demands while still preserving the environment and protecting public health.  

Van P. Hilderbrand is an associate in the Environment, Energy and Natural Resources Practice Group at Sullivan & Worcester LLP, a law firm based in Washington D.C., New York and Boston. Lyndsey Bechtel is an associate at Clausen Miller P.C. in New York.