Water makes life possible. It makes economies function globally.

 

Our water supplies are under severe strain due to growing demand, pollution and climate change. Growing needs of locales from Las Vegas to the Lone Star state are all pointing to a water-constrained future. Re-thinking how we value water is a critical first step in reducing these strains and safeguarding future water supplies.

 

One could argue that the answer to water scarcity is to monetize water. The idea of treating water as a commodity like oil or gold might seem disturbing on its face. Access to clean water ought to be a human right, and the United Nations supported this with a 2010 resolution. Environmental economists suggest applying the free market force — Adam Smith’s “The Invisible Hand” speaks to this issue — by allocating a certain amount of water for everyone for free (or almost no cost) and have a free market for the rest.

 

Water is a finite and precious resource, but our economic systems treat it as limitless and of little value. For many companies and other water users, their water bills are so small that it hardly seems worthwhile to conserve. The result is unsustainable water use across much of our economy — from industry to agriculture to homeowners.

 

Water utilities, oil and gas, and agriculture: These three sectors are responsible for more than 90 percent of America’s water consumption. Use of innovation and technology like drip irrigation, education in water-saving techniques and better pricing structure can provide rational incentives to water conservation measures in agricultural practices, which accounts for 70 percent of the global water use.

 

The business of water

Water is a very capital-intensive business and very fragmented because of the infrastructure assets, such as pipelines, that are involved in the management and delivery of this asset. One cannot wheel water across power lines. And unlike electricity, water is expensive to move, so the transportation cost is huge; the treatment requirements are significant especially to meet regulatory and environmental requirements.

 

Eighty-five percent of U.S. populations are served by a municipal utility rather than an investor-owned utility (IOU). There are 55,000 water utilities; 40,000 of those are extremely small and only nine are IOUs.

 

The municipal bond market is about $3 trillion dollars, and water and public utilities make up 10 percent of this market. The large utilitiess that are regulated and have a good bond rating are successful in going into the municipal bond markets and raising capital. The U.S has a subsidized municipal debt that makes it easier to raise municipal debt. But smaller- to medium-sized utilities are struggling to find capital. They operate on cash-revenues to pay for the operation costs and other expenses of their business.

 

Likewise, large water utilities are expected to see a 40 percent increase in long-term debt in the next five years. To combat this financial and resource crisis, municipalities are becoming more focused on charging rates that cover the cost of debt, cost of operation and cost of replacement infrastructure. This full cost of capital is very critical to addressing the issue of water conservation and efficiency. But municipalities have not raised the rate for the past five to 10 years.

 

Pricing the priceless

Regions with the most serious water availability challenges have the lowest rates for water and sewage services in the country. For example, residents of Dallas pay $9.53 for 3,750 gallons in billable water usage compared to $19.81 for Atlanta, which receives more rainfall. According to Fortune, New York City charges residential consumers $3.37 per cubic meter of water; Chicago is $1.46; and Miami is $1.15.

 

Water is politically sacrosanct: We do not want to talk about paying for water and consider it to be a human right! Utilities seeking to raising water rates to convey the true cost of each additional gallon of water delivered often face considerable political backlash. For example, the mayor of Livingston, California was kicked out of office due to an election recall spurred by voter anger over a water rate increase.

 

But then, keeping in mind the theory of tragedy of the commons, we are headed for a collision course of consolidation or privatization of water utilities similar to the U.K. in 1980s — and even water war — if we do not take steps to improve the cost structure. The City of San Diego is stepping up to the challenge by increasing its water rate and proposing a four-tier rate structure. This new structure, the city says, is designed to provide a greater financial incentive to conserve water, so that those who elect to use far more water will have to pay the higher marginal cost of providing it.

 

The city, which is largely dependent on the depleted Colorado River, has taken steps to promote conservative use of local water resources and decrease its reliance on imported water by diversifying local water supplies. These measures have included the development of a water recycling system, a desalinization system, urban conservation policy and, most notably, an urban-rural water conservation partnership in which the city compensates farmers in surrounding areas for implementing agricultural water conservation measures.

 

Managing water risk with sensible rates

A 2010 CERES report presented key recommendations for utilities, investors and credit-rating agencies to manage emerging water risks in the utility bonds market. These included:

• • Disclosure of material water stresses such as exposure to persistent drought or long-term climatic changes

• • Potential and existing regulatory actions related to environmental flows, assessment of potential capital costs

• • Rate adjustments and revenue effects from water supply risks

• • Strategies to manage demand and reduce leakage

• • Investment in infrastructure

• Rainwater harvesting and natural water capture

A World Bank report predicts the demand for water supply will outstrip supply by 40 percent in the next 20 years. Will this be solved by introducing ‘markets’ inspired by Ronald Coase‘s theory that markets are more efficient at solving properly priced ‘externalities’ than firms or government. I think both!

 

Whenever one is faced with two different paths, each with its certainties and unknowns, you could always take the path less travelled, but the cardinal rule in strategic planning is to take a path that allows you to shift to the other path if your initial decision should prove wrong. We have to apply a systems-thinking approach to this problem — everything is part of the puzzle. As futurist Peter Schwartz advises in his book “The Art of the Long View” — “We should choose the option that gives us the most options in the future.”

 

Image credit: Flickr/Jocelyn Kinghorn