Are finance and budget personnel gate-keepers or operations support staff? The answer make a great difference to your operation. Gate keepers slow the process by creating barriers to overcome (think Dilbert). Support staff means they readily acquire the necessary resources to insure smooth operation (not Dilbert). Which do you have?
The rainy season has sort-of started in south Florida and with it comes flooding and discussions of the falls end of season and concurrent high, high tides for the year, flooding and the impact of sea level rise on low-lying areas. Much focus has been spent on the causes of sea level rise and the potential flooding caused by same. However the flooding can be used as a surrogate to impacts to the social and economic base of the community. By performing vulnerability assessments, coastal areas can begin planning for the impacts of climate change in order to safeguard their community’s social, cultural, environmental and economic resources. Policies need to focus on both mitigation and adaptation strategies, essentially, the causes and effects of climate change. Policy formulation should be based on sound science, realizing that policy decisions will be made and administered at the local level to better engage the community and formulate local decisions.
Making long-term decisions will be important. Businesses look at long-term viability when making decisions about relocating enterprises. The insurance industry, which has traditionally been focused on a one year vision of risk, is beginning to discuss long-term risks and not insuring property rebuild is risk-prone areas. That will affect how bankers look at lending practices, which likely will decrease property values. Hence it is in the community’s interests to develop a planning framework to adapt to sea level rise and protect vulnerable infrastructure through a long-term plan.
While uncertainties in the scale, timing and location of climate change impacts can make decision-making difficult, response strategies can be effective if planning is initiated early on. Because vulnerability can never be estimated with great accuracy due to uncertainty in the rate of warming, deglaciation and other factors, the conventional anticipation approach should be replaced or supplemented with one that recognizes the importance of building resiliency. The objectives of the research were to develop a method for planning for sea level rise, and providing a means to prioritize improvements at the appropriate time. In addition the goals were to provide guidance in developing a means to prioritize infrastructure to maximize benefit to the community by prioritizing economic and social impacts.
Adaptation planning must merge scientific understanding with political and intuitional capacity on an appropriate scale and horizon. According to Mukheibir and Ziervogel (2007), there are 10 steps to consider when creating an adaptation strategy on the municipal level. To summarize, these are as follows:
The strengths of this framework are the initial focus on location-specific science, the use of both economic and social evaluation criteria, and the notion that the plan is not a fixed document, but rather a process that evolves in harmony with a changing environment. The final two steps occur at regular intervals by the community with associated adjustments made. The next question is how to develop the data and priorities.
As you are aware, I have several hobbies and interest, and economics is one of them. Economics has theorists from many different viewpoints, and the commonality among them is that there is no “school of thought” that explains everything. So new schools get developed to explain the current events, or old ones that were discredits are resuscitated, but unfortunately we too often neglect the past, or at least the examples of the past. Too often the obvious gets ignored. For example, we cave money because we know there will be ups and downs. Individual do it, so why don’t governments? We know that we will pay for a product we need. Demand drives the price. If more people want it, the price goes up. Been that way for…. ever maybe? So in my recent reading I came across several musing that keep getting talked about by political pundits, but may be they are not what they appear to be. So let’s take a look at a couple of these that might just affect us….
Is supply side economics is a myth developed by corporate economists to argue for lower taxes. The concept is to give tax breaks to encourage manufacturers and businesses to produce more product which will reduce costs. You know this is patently false. Try selling your reclaimed water at a discount (or give it away) when it is raining. Demand drives the economy, not supply. Every economics student learns this in economics 101. The supply side economics school developed as a means to explain stagflation in the 1970s. The idea what to give tax cuts to those who invested, so they would invest more to make new products, which would trickle down to the rest of us. Still doesn’t work. Why? What they ignored was that the US industrial sector had saturated the US economy with goods and could not grow without new sectors to sell to. Hence the push on Nixon to open up China to foreign trade and investment. But opening foreign markets was great, except they could not afford our products. So we had to make the products there, increase local wages so they could buy the products, and still shipped products back at a cheaper cost that to build them in America. The idea is not new – recall Henry Ford set up the assembly line to cuts costs to allow him to increase wages so his workers could buy his cars. The obvious question is when we saturate China, then what? Africa? Then what? The economy cannot grow faster than the increase in population. So why does supply side economics keep getting traction? Did we mention those tax cuts….
To the big fashion in Germany and the EU is austerity. Austerity is an economic idea that never seems to die despite very limited success and many, many failures. It sounds great – cut costs and balance the budget while cutting revenues (income). Ok, so let’s see how that works in your household – you quit your middle class job and take a minimum wage job. You cut your expenses. Except you can’t sell your house without a loss (and you do not have the cash to make up the difference) and you need your car to get to your new job. But austerity says that if you eat rice, beans, cereal and Ramen noodles, you will soon be far better off than you are now. No one will suffer. Do you believe it? Do you wonder why the Greeks and Irish are not doing so well today and why people are restless? They used to devalue their currency, but the Euro prevents this. They do not have away out. Meanwhile Iceland devalued currency, let the banks fail, took over the bank assets, and are doing much better. Austerity was not the option…. Just saying… And who suffers the most? Not the high income folks.
Tax cuts stimulate the economy. Sounds great. But, from 1944 to 1963, the income tax rate on the highest earning bracket in 1960 was 90% over $200,000. Yes 90%! The economy was great. The middle class was born. House ownerships jumped. Education was up. The economy in the 1970s stagnated after we cut tax rates. We cut the income tax rate in the 1980s, but raised other taxes, and things improved, but then declined. The economy improved after the Bush tax hike in 1991. It did not improve after the Bush tax cuts in 2001. Interesting in their book Presimetrics, Mike Kimel and Mike Kanell noted that higher taxes seem to correlate with a better economy. Is it because investors can’t sell stock so easily when they made a profit so corporations can count of investments longer? Or is it that the increase in revenues allows the federal government to invest in more research and development that further stimulates the economy? Did we mention the tax cuts favor the wealthy?
The moral of the story is that utility managers cannot ignore the economic realities around them. We cannot be trapped by the musings of people who have hidden agendas, which means that our understanding of the way things are must extend beyond the utility itself. The economy, economics, monetary policy, tax policy, demographics and change are areas that utility managers need to be current on. Engineers and managers often understand these issues easily (most are mathematical) but we tend to focus only in out areas. We need to become educated. Recall the earlier blog where I noted the city manager who realized later that the reason elected officials tended to bad alternatives was they were being lobbied to approve the poorer options because their clients could make money from it. You know many ideas that will be lobbied to elected officials and business people in the future. You need to become educated on these ideas and how they affect your utility. You know that rates that are too low will not increase revenues. You know you need to expand sales when possible, perhaps serving new areas, and making the investments for same. You know that not spending money will only increase the risk of failure in the system. You know that not increasing pay will disenfranchise employees. Prepare for these assaults so you can lead your utility down the proper path.
A week ago the new National Climate Assessment came out. It basically says things we already expected – temperatures are warmer, there will be more droughts, less rainfall, less available water, more intense storms and sea level rise. What the study did in its 800+ pages was outline examples of climate change phenomena that are already occurring including flooded streets in coastal areas, severe weather (Colorado, New Jersey), and changes in the arctic air currents that may be affecting northeastern and Midwestern winter storm frequency. All things that those who have been around for a while and have been even minimally observant have already noticed for themselves. What was also not surprising was the vitriol on the internet about how this assessment was a “fascist plot” perpetrated by a variety of people to impose some yet undetermined regulations on “patriotic Americans.” And then Senator Marco Rubio comes out this week and says he does not believe it is possible for people to cause climate change. No facts, just belief. In Florida. In Miami. Wow…
Those who live in coastal areas, earn their living in agriculture, manage water utilities relying on water supplies, and drought planners know the truth. Denying that the climate is changing simply ignores reality and delays the ability to respond to its impacts. I realize that those impacts might be 20 or 40 or more years out, but planning is needed because we expect our infrastructure, factories, hoses and economies to last longer than that. Science says change is occurring. We can argue why and how fast, but the reality is that there is change and there are many people that will confront he need to adapt to the situation sooner than later (like us the Fort Lauderdale/Miami area!). So why deny climate change?
As we noted in a prior blog, there are several reasons, but many involved business issues. So follow the money. Let’s start with the Koch brothers. The Koch brothers manage Koch Industries, the second largest privately owned company in the United States revenues exceeding $100 billion/year. Many Americans have no idea who they are but they are billionaires who have made their living in the oil business – their father Fred C. Koch developed a new the method for the refining of heavy oil into gasoline. They rely on oil to maintain their wealth and are politically active with conservative organizations including the Heritage Foundation and the Cato Institute, FreedomWorks and Americans for Prosperity, all organizations the dismiss any impact of man on climate change. Why? Well one of the tenets of dealing with climate change is to reduce carbon dioxide emissions which means less reliance on fossil fuels – oil. Whoops – that would be a problem for the Koch brothers because if they say “sure climate change is a problem,” well then that would mean that their entire business model and their wealth is a contributor to climate change, which means they are the “bad guys.” Can’t have that. So following the money tells you that we can’t make our money with oil and support climate change.
Let’s look at the other side. Those acknowledging climate change are fully supportive of renewables, which in theory will help climate change by reducing carbon dioxide. But the concept of renewables though is fraught with the problem that few of these technologies are ripe for wide-scale implementation. For example natural gas vehicles or natural gas/hybrids are doable, but where do you buy the natural gas for the vehicle? The technology and distribution networks is 10 or more years out at best and of course if you are in the oil business, why would you be interested in installing the natural gas fuel pumps? So technology and need do not match when you follow the money.
How about the Keystone pipeline that would bring oil and gas from these remote areas to refineries in Texas and the Gulf of Mexico states. You can guess the Koch brothers are in favor of the pipeline as they will benefit. So are most oil and gas entities. There are many environmentalists and other opposed to the pipeline because of impacts on water supplies (and other issues). But the railroads are making money by hailing oil and gas from Canada and the Dakotas. Guess which side the railroads are on? The pipeline would take business away from the railroads. Follow the money.
Let’s look at our industry. In the utility business, there is a lot of money with the telephone, power, cable and other utilities. These private entities, although regulated, make huge sums of money for their investors. You can follow that money.
So who supports water and sewer utilities? We do! We supply over 85% of Americans. But why do we have so much trouble getting funding when 85% of people would benefit. One would think that given how many people we support, we have the money, but we are primarily not-for-profit entities, so we don’t make money for anyone. You can’t follow that money because there is no money. That tells us more about the difficulties we have in securing funding that anything.
Fixing it is a little bigger challenge because our representatives and constituents do not understand the financial investment they have in our industry. Their public health and economies are linked to water and sewer. Our services make these other enterprises doable but there is no direct monetary connection to facilitate lobbying on our behalf. I am not sure how to fix this, but we need a better marketing strategy for our services. That’s one thing we know.
I had to share this, from a nonscientific survey of people adamantly opposed to any consideration of changes to our climate:
1. I can’t do anything about it so I don’t care about it
2. People can’t alter what is happening with the earth because it is too big
3. It’s natural, so we can’t do anything about it
4. It’s not an issue now, so it’s somebody else’s future problem
5. The science is inconclusive so why do anything yet. Let’s see what happens
6. Trying to address it will cut jobs
7. We won’t be competitive (i.e our profits will drop)
8. It requires changing our business model (energy)
9. If we talk about it no one will develop in our community
10. Costs too much
I had to post this as many of you will have comments. But before you do, these about this a minute……
The first five are based on no facts, but a desire to ignore the issue entirely. The second five are more poignant because aren’t these pretty much the same arguments to deny the need to correct water pollution concerns in the 1930s? Or 1950s? Or even 1970s? Or even today with hog farms, frack water, acid mine waste, coal dust slurries, etc.? Or actually pretty much every regulation? I seem to recall Tom Delay making this argument when he was in Congress before he was indicted.
Now think about the Clean Water Act, Clean Air Act, Safe Drinking Water Act, and others. These regulations are designed to correct ills of the past that were simply ignored due to the first five arguments above, ignoring the fact that prevention is always less costly than cleanup afterward. To we pass regulations to clean up problems and protect the public health going forward. Otherwise why have a regulation?
So let’s talk about that jobs impact. The reason is that after the passage of these regulations, didn’t the number of professional jobs (like civil and environmental engineers, environmental and other scientists – STEM jobs) increase? Isn’t increasing STEM jobs a priority? So won’t dealing with climate issue perhaps create a similar increase in STEM jobs? Yes, costs for water increased and the cost for the effects of climate changes will cost money, but don’t these challenges create opportunities? Isn’t this akin to dealing with problems with development from the past? Just asking…..
At a recent conference I was listening to a presentation by the Army Corps of Engineers explaining the investments made over the last 80 years. Subsequent presentations discussed that the need to reinvest in infrastructure appears to be about 3.6% of infrastructure value per year, but that the US is spending about 2.4%. The best condition of our infrastructure was in the 1980s, but decreases in reinvestment due to funding limitations has caused an ongoing decline in infrastructure value, which is why the ASCE report cards show most of our infrastructure at the D or D- level. It is getting old and it needs repair and replacement. You would rarely buy a house, never maintain it, and expect it to live in it without problems for 50 years. Roofs leak, pipes need replacing, mechanical equipment, lights and appliances fail. It is the cost of owning a home. You have to update. Most times the new equipment is more efficient that the old stuff, saving money. So why do we do this with infrastructure?
More interesting was the response to how some of these agencies may deal with this backlog of deferred maintenance. So far I have heard the Corps, state transportation agencies, state land agencies and another federal government say that they are figuring out means to prioritize the assets and dispose of those not needed. So let’s see how that would work and I kid you not, these are suggestions:
Hey I like the idea of giving, but seriously, how does the “recipient” deal with this problem. The low value assets are low value because they serve limited people and are deemed to have little economic or useful value or are too expensive to maintain. So what does the recipient do with it? They do not have nearly the resources that larger governmental entities have, and if the big guys cannot find the money, will locals? Are we just kicking the problem to the next guy? Sounds like used car sales to me.
It sounds suspiciously like the argument I have heard several times from a city manager who talked about cutting the size of local government, only what he did was contract with other entities to do the services, which means cuts in employees for his city, but the cost is just transferred to another entity. The rate/taxpayers will foot the bill unless the service is completely discontinued. In his case, they all paid more.
The State of Florida and the federal government have both cut employees and both contract heavily for services that never used to be contracted. There is a whole industry of contracting for government work that used to be done in-house. In other words, they privatized portions of the operations. But did the cost of government decrease in either case? No.
So going back to the initial question – will governments abandon infrastructure? The answer appears to be yes, but the problem is that that infrastructure IS being used by people so the reality of full abandonment is impossible. The result will be that underlying local entities will be stuck with the bill. Planning is needed. “Fail to plan = Plan to fail” as my friend Albert says. We need to identify where these “gifts” may occur and identify a means to deal with the inherent obligation that goes with them. For water and sewer utilities, waterways and roadways are of particular concern, but so could watersheds and well sites.
So Detroit defaulted on it’s debt obligations. Do does that impact you? Well, that depends on whether you are a utility looking revenue bonds, a city looking for general fund bonds or some combination. The issue in Detroit with debt is that they pledged the full faith and credit of their taxing authority to repay the debt. Their taxing ability was insufficient to accomplish this goal, which means that there could now be distrust in that promise for other cities. So if you are a city and you are making this pledge, Detroit could impact you, or at least create more review on your balance sheets. If you are a utility that is pledging revenues that have no limitations on amount, the concern is likely less. Of course in either cases, the question is what the rest of your balance sheet looks like. If you have no reserves, do not charge the full cost for service, have a heavy debt load, have high rates already, or send a lot of funds to the general fund, that could be a problem. If you have avoided these pitfalls, the bond market will see much less of an issue.
Keep in mind that Detroit is not the only default – another big one is the Birmingham and several other create questions about general fund uses of funds, which makes it of greater importance to keep our financial house in order. IN part this can be done by creating the appropriate enterprise funds and remove those services from the general property tax fund. That permits local focus on the true cost of general taxing users and creates a delineation between general fund and enterprise costs. That can help elected officials focus on the true general fund issues: police, fire, EMS, administration without hiding those costs with subsidies from other funds.
I read a recent article in Roads and Bridges on the reconstruction of the roadways to Estes Park. An excellent effort by state officials and private contractors to rebuild over 20 miles of roads that were wiped away in mid-September when unprecedented rainstorms cut Estes Park off from the front range. I actually had reservations in Estes Park as part of a plan to go hiking at Lawn Lake, among others. Lawn Lake was one the harder hit areas in the park. Went to Leadville. If you have never been, go. The early money in Colorado came out of Leadville – silver was the money-maker. I did a 12 mile hike thought the mining district as it snowed – note it is the 2 mile high City. Great hike in the am – the photos were fantastic as well.
But the point is that people expect government to solve problems like the roadways in Colorado. They expect we will solve water, sewer and storm water problems. We have done a great job of it because people take these services for granted. What we don’t want is to have a catastrophic failure, natural or otherwise.. ..
We all know that our infrastructure is deteriorating. Deferred maintenance increases the risk of system failure. The need for capital reinvestment within the utility industry has historically been very low. As a result, in its “2013 Report Card for America’s Infrastructure,” the American Society of Civil Engineers assigned a grade of “D” to America’s drinking water systems, citing billions of dollars of annual funding shortfalls to replace aging facilities near the end of their useful lives and to comply with existing future federal water regulations (ASCE, 2013). AWWA estimates that investments of at least $1 trillion are needed over the next 25 years.
While a pay-as-you-go capital funding seems like the best way to go, that is difficult to accomplish with the large outlays needed to upgrade the infrastructure system and the controls on rates often exercised by local officials. As a result, borrowing is required and the condition of infrastructure and the lack of reserves are a part of how the utility is viewed by those who lend monies. Utility managers need to understand how the lending agencies evaluate risk.
Lenders use many tests. Among them are: whether the utility’s annual depreciation expense is used of accumulated as reinvestment in the system, whether adequate reserves are present, whether annual capital spending that is below the amount of annual depreciation and the amount of revenues in excess of projected debt (debt service coverage). The target debt service coverage may depend upon the requirements of the underwriter, the rating agencies and the investors. Debt service coverage could be as low as 15% or as high as 50%. In 2012, the median all-in annual debt service coverage excluding connection fees for utilities rated “AAA” by Fitch Ratings was 220%, while the median for AA-rated and A-rated utilities was 180% and 140%, respectively. (Fitch, 2012).
A working capital target of 90 days of rate revenue is a minimum, but since 2008, more is likely to be required depending on the size of the system and the history of revenues. Where the revenues were stable despite 2008, less may be required. For those utilities that suffered major decreases, reserves should be far larger – perhaps a year or more. Other criteria that could be used to evaluate the projects when borrowing money include public health and safety, regulatory compliance, system reliability, the risk and consequences of asset failure, redundancy, community/customer benefit and sustainability. At the same time, the expectation is that the utility systems that retain all monies in the system to be utilized to improve the system and pay for debt service, except those used for the purchase of indirect services from the General Fund that are justified with indirect cost studies.
Despite the above, rate are an issue. Fitch Ratings has indicated that it considers rates for combined water and wastewater service that are higher than 2% of the median household income – or 1% for an individual water or wastewater utility – to be financially burdensome (Fitch, 2012). The Environmental Protection Agency (EPA) considers that rates for an individual water or wastewater utility that are greater than 2% of median household income may have a high financial impact on customers. (EPA, 1997). Utilities with a stronger financial profile might have residential charges for combined water and wastewater service that are less than or equal to 1.2% of median household income, or less than or equal to 0.6% for an individual water or wastewater utility. All revenues generated through system operations generally must remain within the system and can only be used for lawful purposes of the system.
Canadian utilities employ more formal polices to establish fiscal policies to provide reserves to insure stability in the event of unforeseen circumstances. Reserve targets focus on ensuring liquidity in the event there is an interruption in funding, increased capital costs due to new regulatory requirements or a short term funding emergency – all the issues evaluated by the bankers. Reserve targets are policy decisions. Benchmarking is an evolving practice within Canadian public sector utilities particularly as it relates to financial planning and capital financing. The benchmarking exercise provides valuable information to help assess fiscal performance, the needs of customers, and provide the tools to help support optimum performance.
We have talked about reserves, the need for them, reasons why they are neglected and how to establish appropriate numbers (an area where more research is needed). Reserves are an issue when the economy tanks. We all recall the problem in 2008, but this is where utilities need to look beyond just their system to see what might be coming. 2008 was a problem that we should have seen coming, or at least planned for, but did not. But it means that we need to look at the national and local economic picture and understand a little about events beyond our reach that can affect us. Utilities and governments generally do not do this well.
In 2005-2007, it was very clear we had a property bubble going on. There was discussion on the news, financial channels, Wall Street Journal and even columns by economist like Paul Krugman. A few of us may have taken advantage of the bubble through prudent real estate sales, but many did not. Likewise, few utilities or governments planned for its inevitable fall. After the crunch hit, those who owed the least amount of money, had savings and had stable incomes fared better than those who did not. Same for governments. Unfortunately most Americans and most governments fell into the “did not” category.
So let’s look at a couple issues. First, we knew there was a bubble and should know that all bubbles pop. We had the tech stock bubble in the late 1990s. People on Wall Street knew that the investments had turned to real estate and bankers where busy loaning money out with no interest for two years, no money down, adjustable rate mortgages and the like. If you owned a computer you were inundated with Countryside and various other folks trying to loan you money. Or buy your house and pay you an annuity if you were older.
The reason that these “opportunities” were so prevalent was to help speculators who expected to own the property for short periods of time, or help those who might not have the means to buy time to get the means to support the payments. All the subsequent financial instruments discussed in books like “Too Big to Fail” come from tools used by bankers to disperse the risk associated with speculators and the risky. It made money for bankers and investment houses (remember they are private businesses beholden to their private stockholders).
Like all bubbles, we get caught up in the money being made by speculators (and yes if you invest in the stock market you are speculating). We try to grab onto the rising instruments to get ahead, but we forget that especially with real estate, the growth overall rate across the nation could only grow at the rate of population growth. It is basic supply and demand.
For governments, revenues rise, especially during real estate bubbles. Some bubbles last for years, which creates a distorted view of the future. In south Florida, there was a lot of buzz concerning water supply projections and arguments between regulatory staff and utilities over water supplies that were projected 20 years in the future, based on demand projections from 2000-2005. When the dust settled in 22011, most of those issued disappeared because virtually all projections were substantially revised downward. And most revenue growth projections were likewise revised downward and capacity needs delayed. Planning 20 years out is historically inaccurate because the global economy can impact local growth.
Of course these new projections are incorrect as well. Because the test period was 2005-2010 or 2000- 2010, the growth is stunted. So they are likely underestimating demand and revenues. Uncertainty with time means that the accuracy of projection decreases with time. As a result, simply relying on past projection methods increases risk that of significant deviations.
I do an exercise n class where I give students three sets of projections. 10 years apart, for 50 years. I tell them nothing else. The examples are The State of Nevada, Cleveland, and Collier County, FL. All are in the past (Cleveland is 1910-1950) There is absolutely no easy method that can project the growth in either Collier County or the State of Nevada, or that Cleveland’s population will drop in half. We could do the same with Detroit and never project that decrease either. But when you tell them where the population are and what year, the wheels start to turn. They realize that economics is a major issue. While Nevada and Collier grew from 1960-2000, the rate of change is likely to be very different in 2010 to 2020 due to the 2008 recession.
Tracking economic activity is a utility responsibility. We need to know what is really happening, and understand bubbles. We need to recognize that when property values and housing number increase fast, it will be short term. Plan for savings and reserves. Figure out what your recovery period might be. We need to understand our economic base. For example try this out and see what your conclusion is. Florida’s economy is based on three major industries: agriculture, tourism and housing. What could possibly go wrong with that model? Well if we have an economic problem nationally, 2 of 3 take major hits because people outside the state do not travel to Florida and retirements get put off. The economy gets hit hard and recovery is slow. We have experienced that exact phenomenon from 2009 to date. And many of those jobs are low wage positions which means the people who struggle most get hit hardest. Storm events can impact the state. Bit hits to all three, and agriculture is also a low wage industry. It is a precarious economic model that sets itself up for potential fluctuations. We need to plan for this. It is our responsibility, utility staff and decision-makers to plan and prepare for the next big event.
publicutilitymanagement 