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In a prior blog we talked about the difference between urban and rural counties and the impact of the differences between incomes and how that would affect utilities.  Keep in mind that the 40 largest urban counties in the US contain nearly half the US population as do the 50 largest utilities.  So in a recent article in Governing, the focus was on the few counties where income was higher than average.  In fact, in looking at counties, within the top 20 in per capita income are 10 counties in North and South Dakota.  Interesting until you review why.  All are in areas where fracking is ongoing and corporate farming is prevelant.  It is no surprise that the fracking boom has created wealth in rural areas that have limited populations, limited regulations and state and local officials who are desperate to reduce unemployment and stimulate laggard economies.  We noted before that rural counties are often desperate for jobs, so they often ignore what could possibly go wrong when jobs and development are the only priorities for a community.  Governing used the example of Wells County, ND where the per capita income has doubled since 1997 and is 75% above the national average.  Yet the local governments are looking at which roads they will allow to go back to gravel.  How is this possible? 

The issue is not relegated to just Wells, ND.  Despite the fact that many rural communities in areas with intensive farming or fracking have grown 10-15% since 2007, local officials are finding it difficult to raise taxes to pay for infrastructure.  Roads are the most obvious and pressing issue because of the impact from fracking traffic.  As new wells are constructed, the frackers build new dirt roads and use the existing roadways.  Some believe the need to fix many of the roads is temporary so why bother, but it neglects the need to infrastructure improvements in general.  The same argument could be used for water and sewer infrastructure as well, but these wealthy rural communities do not want to increase governmental spending to improve any infrastructure, so the opportunity to address the community needs is being lost.  

What is more interesting is that the states where these rural counties exist, including the Dakotas, along with Montana, Wyoming, New Mexico, and most of the southeastern states are among the states that rely most heavily on federal funding.  So when incomes increase, the dependency remains.  These are the same states that tax residents the least, spend the least on education, have the poorest health care (and the fewest people signed up for the Affordable Care Act and few have state exchanges) and have the most people in poverty.  The dichotomy between reality and the political perception is interesting in these states, which leads one to wonder if the residents of these states like their situation and keep electing representatives that reflect this desire, or they have fallen victim to political interests that cause them to vote consistently against their better interests, or for the interests of a limited few that deny them access to the education, infrastructure, medical care and other benefits their urban and wealthier neighbors enjoy. 

That is a tough question but the bigger question is how to infrastructure agencies like utilities attempt to overcome either of these perceptions?  Neglecting infrastructure, education, medical and the like does not promote local economies, does not create jobs and more likely causes the migration of the best and brightest young people out of the community in search of better prospects, which further imperils their rural situation.  Keep in mind that most cities are relatively permanent, but fracking, like mining, oil and timber before them, have been booms and busts.  The situation if far more dire after the boomtown than it was before.  After all, what could possibly go wrong when 50,000 miners, or frackers, descend upon a community of 1,500 people?  They will consume all the resources, then leave.  Locally those well paying jobs are imported due to the lack of skills and education, and then they leave with the bust.  This has played out many times in the past.  It is not sustainable.  We need to learn from the past – when the boom hits, make the investments you need in infrastructure, education, medicine, etc. so that the future is better after the bust. 

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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. 

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