The “Gap”

Understanding the Challenge

Prepared for the North Carolina American Water Works Association & Water Environment Association

Training Seminar

Steve AllbeeU.S. EPA

September 7, 2001

What I need is a list of specific unknown problems we will encounter.

E-mail is not to be used to pass on information or data. It should be used only for company business.

This project is so important, we can’t let things that are more important interfere with it.

Doing it right is no excuse for not meeting the schedule

No one will believe you solved this problem in one day! We’ve been working on it for months. Now, go act busy for a few weeks and I’ll let you know when it’s time to tell them.

Quote from the Boss: “Teamwork is a lot of people doing what I say”

We know that communication is a problem, but the company is not going to discuss it with the employees.

(Original source unknown).

Here are some finalist in a Dilbert Quotes Contest.

The content of this presentation

Looking back - - A brief overview of spending trends and what they suggest

looking forward - - Estimates of future needs compared to current spending

The evolution of asset management & the impact of GASB 34

Innovations in management strategies

Case studies of local situations

Are the challenges ahead foreseeable?

Could it be ?

Looking Back

-- The Money --

The country invested more than $1 trillion in constant

$’s over the past forty years

The funds are mainly from local sources:

Water - - only 3% of funds have been federalWastewater - - only 23% of funds have been federal

In Ohio the Average Sewer and Water Fees Doubled between 1983 and 1999

(actual dollars not adjusted)

$0

$100

$200

$300

$400

$500

$600

$700

1983 1985 1987 1989 1991 1993 1995 1997 1999

Sewer Water

What Ohio communities reported Ohio households paid for water and wastewater fees

($ are not adjusted)

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

Lessthan$100

$200to

$300

$400to

$500

$600to

$700

$800to

$900

$1000or

more

Number of Households

1989 1999

In constant dollars more than 60% of the households did not have income growth 1989 and 1999

(census data 1999 $'s)

$0

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

$140,000

$160,000

LowestQuintile

SecondQuintile

ThirdQuintile

FourthQuintile

Lower limitof top 5%

Household income

1989 1999

We also know that during this same period the kind of spending that produces efficiency and

productivity gains declined.

Source: Ohio

Looking Back

-- Environmental Results --

Over the last 30 years, the capital spending has been for upgrading and expanding systems to improve plant

performance and serve more households.

H i g h e r l e v e l s o f t r e a t m e n t

7 2 8 2 9 2 9 6

T o t a l P l a n t s 1 9 , 3 5 5 1 5 , 6 6 2 1 5 , 6 1 3 1 6 , 0 2 4

L e s s t h a nS e c o n d a r y 1 3 . 4 % 1 9 . 9 % 5 . 6 % 1 . 1 %

S e c o n d a r y 4 8 . 7 % 5 0 . 7 % 5 8 . 2 % 5 8 . 6 %

M o r e t h a nS e c o n d a r y 2 . 4 % 1 7 . 6 % 2 3 . 6 % 2 7 . 6 %

N o D i s c h a r g e 2 . 4 % 1 0 . 2 % 1 2 . 7 % 1 2 . 7 %

Even though the population and economy increased BODU decreased significantly

0

5,000

10,000

15,000

20,000

25,000

1968 1972 1978 1996

Metric tons per day

Looking Forward

-- Environmental Objectives --

Principle Causes of Impaired Waters(305 (b) National Inventory)

Point Sources Only10%

Combination of Point & Nonpoint Sources

47%

Nonpoint Sources Only

43%

Growth in the economy and population, could produce by 2016, BOD loading rates similar to the mid-1970s

Looking Forward

-- The Costs --

Wastewater infrastructure estimates (2001 $ in billions)

Existing Debt Service

New Debt Service

Pay-as-you- go

O&M

$0

$10

$20

$30

$40

$50

$60

Wastewater infrastructure capital estimates (2001$ in billions)

Replacement

Documented

Modeled

$0

$5

$10

$15

$20

$25

1990 1995 2000 2005 2010 2015 2020

Looking Forward

-- Renewal and Replacement --

U.S. Population 1880 to 2000

0

50,000,000

100,000,000

150,000,000

200,000,000

250,000,000

300,000,000

Number of people

Total Population 100 largest CitiesPopulation of Urban Areas Estimate of Population ConnectedCensus Data on Connected Population

Histogram of the miles of pipe installed per decade

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

1890 1910 1930 1950 1970 1990

Miles of pipe

The aging of the pipe network

0

50,000

100,000

150,000

200,000

250,000

20> 30 40 50 60 70 80 90 100

Years in Age

Miles of Pipe

1980 2000 2020

Renewal and replacement of pipe is a relatively new issue

0

200,000

400,000

600,000

800,000

1880 1900 1920 1940 1960 1980 2000 2020

Miles of pipe

All Pipe Installed

Deteriorated Value

The increasing difference is the

problem pipe

A projected deterioration pattern for 100 year pipe

0

0.2

0.4

0.6

0.8

1

2 12 22 32 42 52 62 72 82 92

Percentage Effective Life Elasped

Condition Classification

Excellent

Good

Fair

Poor

Very Poor

The shift in the amount of pipe projected in the lower three

conditon classifications

0

100,000

200,000

300,000

400,000

500,000

600,000

Excellent Good Fair Poor Very Poor Life Elasped

Typical Classification Categories

Miles of Pipe

2000 - 8%

2020 - 55%

Wastewater infrastructure capital - the big change is that for the first time

renewal of the existing systems will have a major impact on financial requirements

Replacement

$0

$5

$10

$15

$20

$25

1990 1995 2000 2005 2010 2015 2020

Wastewater Needs and Gaps - Annual AveragesInvestment, Cost and Payments 2000-2019)

$0

$10

$20

$30

$40

$50

$60

CapitalInvestments

(not financed)

Capital cost(financed)

Operation &Maintenance

Total Cost(incl. O&M)

Payments forcapital

Investments

TotalPayments

2001 $ in Billions

Current Need Gap

There are significant similarities and a few differences in the projects associated with the drinking water.

Annual Replacement Needs for Transmission Lines and Distribution Mains, 2000 - 2075

Projected Replacement Needs

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

2000 2010 2020 2030 2040 2050 2060 2070

Year

Pe

rce

nta

ge

of

Re

pla

cem

en

t N

ee

d

*You can find a detailed twenty cities report from AWWA at: www.win-water.org

A summary

of the Current Situation

A lot more people are served at significantly higher levels. Water quality improved, but more challenges await

Looking back - progress in plant performance more than offset the impact of a growing population and economy

Looking forward - leveling off efficiency gains in plant performance will make it hard to continue to offset growth

To make the gains, cost went up and so did fees. For many households, the fee increases outpaced income growth.

During the same time that costs were growing, investment was reduced on the types of spending that produce innovations and productivity gains leading to greater efficiencies.

The bottom line is if you look out twenty years, it calls for twice as much as we current spend to make needed new investments, repair and renew existing systems and operate and maintain the systems.

So what does looking back and looking forward tell us?

A “Gap Analysis” is a method of assessing the differences between current asset management practices and the future desirable asset management practices

A “Gap Analysis” is a starting point

The nature of the challenge is such that a strategic direction should place equal attention on all aspects of the asset management problem

•Adequate fiscal arrangements,

•Application of best practices, and

•Innovation leading to productivity gains that may lower cost of meeting objectives

How do you begin to tackle the challenge?

Increased and improved financial tools

Incentives for innovation and new technology

Sustainable approaches; including adoption of best management practices, right sizing of service delivery, asset management approaches, adoption of environmental management systems and emphasis on efficiencies

Affordable, yet appropriate rates sufficient to cover cost, yet not limiting service to lower-income households

Smart and efficient water use

Integrated system wide thinking on reliable onsite systems

Watershed-based decision making

Transparency of subsidies

So what are the basic elements of a successful strategy?

The appendices provide details on asset management, innovations and case studies to corroborate the

national picture

The system is not crumbling into ruins, but it is getting older and it needs serious

reinvestment

Continuing to defer action will cost a lot more in the long run

With the gap analysis, we have been very engaged in facilitating and working with stakeholder organizations on developing a collective view of the size of the challenge.

We have funded a project with AMSA, AWWA, WEF and AMWA to establish a best practice manual for asset management and they will be hosting a series of how to workshops over the next year, at various locations.

We are about to kick off a conference with WERF to take a look at research to ease a transition to asset management

Next on our agenda is to explore approaches to foster the much need innovations in the provision of services.

What is EPA doing to help close “the Gap” ?

Looking Forward

-- Appendix A--

Introduction to Asset Management

Asset ManagementAll physical assets deteriorate with time !

The effective utility needs to be able to plan and optimize the maintenance and replacement cycles for its assets to:

Minimize cost

Maximize dependability

The process of doing this is Asset Management

To maintain and operate, at minimum overall cost a system of assets which provides the operating capability to deliver water, wastewater and stormwater drainage services of the specified quantity, quality and reliability

To acquire, as necessary and at minimum cost, new assets to provide essential improvements or financially viable expansion of the corporation’s operating capability

If you are in the Asset Management business What are you trying to accomplish is

ASSET MANAGEMENTFocus on optimizing life cycle

costs

The current approach to capital investment

Performance

Time

Performance

Time

An Asset Management approach (Life Cycle)

The idea is to push toward increasing equity value & efficiency

Equity Value

Efficiency

A Win - Win Position

So what are the key steps ?

Information System

Asset Identification

Service Level Definitions

Condition / Criticality Assessment

Prioritize Activity

Decision Making

Continual Review

State and local government financial records are maintained in accord with generally

accepted accounting standards The Governmental Accounting Standards Board (GASB)

released a new rule (GASB 34)in June 1999, it changed how financial statements are presented:

GASB 34 moves government toward a business accounting model.

Report on the overall state of the governments financial health, prepared on a government wide full accrual basis.

Provides the most complete information ever available about the cost of delivering services including a charge for the consumption or preservation of assets.

Includes for the first time information about the governments public infrastructure assets (including water, wastewater, storm water asset, etc)..

The Purpose of GASB 34

Disclosure

Provide information about the long term viability of the infrastructure assets of a community

Introduces “preservation reporting”as a reflection of true value

True value is based on an asset management system that reflects maintenance and reinvestment and is based on a systematic condition assessment by knowledgeable persons.

In the initial years depreciation schedules will probably be the most likely approach, however, Asset

Management is on the way

Preservation reporting ( or) alternate compliance uses an asset management system that:

Has an up-to-date inventory of infrastructure assets

Performs condition assessments of assets

Estimates each year the annual amount to maintain assets

Documents that assets are are being preserved.

The American Public Works Association has already endorsed the alternate compliance approach for infrastructure investments such as water and sewer systems

The First Generation.

Some form of basic systemUsually involves an inventoryA set of depreciation ratesA plan of the system with ages and

types.

Judgements are made about replacement decisions by technical staff and through the rationing of capital budgets.

Many small and medium organizations struggling to meet these basic needs. This mode of asset management may continue to be appropriate for small discrete systems.

The Second Generation.

A focus on better data sets and internal planning Geographical information management systems Systematic collection of a range of other data Nessie curve analysis Benchmarking against a range of system

performance parameters Undertaking a range of technical analysis Using a range of technologies to save dollars Some form of strategic or business plan that

helps set budgets from the organization’s perspectiveThis generation is well developed and there is a

lot of information documenting the approaches and techniques.

The Third Generation.

The creation of a set of performance outcomes by which customers, health and environmental agencies can judge the performance of the networks (external accountability)

The collection of good cost and performance data that is able to be externally audited

The development of a set of sophisticated analyses, procedures and systematic framework that minimizes long term costs while meeting required standards of performance by the service provider

Good documentation and often computer automation of this asset management system

Evidence of continuous improvement of the asset management system

A demonstrated record of achievement against budgets and performance measures verified by auditors

Notice the similarities to EMS approaches

Asset Management is very much related to GASB 34

GASB 34 will be implemented over a three year period from 2001 to 2003. The implementing date depends on the total government revenues for 1999 By July 2002, if greater than $100 millionBy July 2003, if $10 million to $100 millionBy July 2004, if less than $10 millionPlus three years to implement infrastructure valuations

Or end of year, if other than JulyThe last 25 years

Some big pathway decisions need to be made early in the process

Best practice, a team approach across your engineering, operations, and accounting functions to put together your game plan.

If you haven’t started already, tomorrow would be good

You have a 4 year grace period for infrastructure, so take small steps and do it right

Within five years you will need to demonstrate that you are maintaining your assets at the condition target you selected

You will need to be able to demonstrate that you have a systematic methodology for determining asset condition

You will need to demonstrate that your budget results in the protection of your assets

Or, you will get a non-compliant mark in your financial report and that may effect your bond ratings.

This is very important

0

0.2

0.4

0.6

0.8

1

2 12 22 32 42 52 62 72 82 92

Percentage Effective Life Elasped

Condition Classification

Excellent

Good

Fair

Poor

Very Poor

The service provider picks the

point and then must budget to

stay at the selected condition target

Appendix B

A Reform Agenda

The Australian Water Industry

About the same size as the U.S.

And only 20 Million People

Fast Facts:Six States & one Territory

A Federation

Climate is temperate to hot

Most the population lives in urban areas

Water is very important

Basic Policy

Water reform is a vital national priority that has implication for the future wellbeing of all Australians

Water is critical to all economic activities and its management and use is inextricably linked to the protection of water quality and environmental process

The water reform initiatives have been formulated with a recognition that an important part of the solution lay in significant policy and institutional change

The Council of Australian Governments (COAG) directed inter-linking changes

Price water for full cost recovery

Establish secure access to water separate from land and provide for permanent trading in water entitlements

Water service providers are to operate on the basis of commercial principles

Improve the institutional arrangements

Engage in public consultation

Foster public education

What are the similarities?

Three levels of government

The same technologies

Pursuing equivalent environmental outcomes

Similar association sectors (AWA) & (WSAA)

Very similar current challenges

Renewal of aging systems

Higher levels of treatment

Wet weather

Continuing water quality degradation in key inland waters

How is the industry different?Urban water from the point of source acquisition through initial treatment, distribution, collection, treatment and reuse or discharge is managed as a government owned vertically integrated business

Services are typically delivered under large regional area service arrangements

The services are well on there way to being commercially based & sustainable

Over the last decade asset management has become a fundamental driver in the water industry

Risk management plays a larger roll in decision making

Water reform has been a big deal for the better part of the last twenty years

The structure of the corporate businesses They are created by State law & government owned

The businesses are managed the same as any private corporation, they earn profits, pay dividends and have tax equivalent charges, they are licensed to operated by an environmental regulator and their have their price overseen by an economic regulator (they are by definition monopolies)

There is a Board of Directors selected the same way as a corporate board is selected

The corporation has three equal drivers; strong commercial performance, meet license (environmental) requirements and fulfill community service obligations

They prepare annual financial reports and their finances are externally audited and reported against corporate standards

Large State in land area

Around 7 million people

4 million in Sydney Region

Both government owned corporation type models and rural community utilities

New South Wales

Hunter Water - Serves 500,000 Hunter Water - Serves 500,000

Charter “ To be commercially successful while delivering value-for-money water, wastewater and associated services in an environmentally responsible manner”

Objectives (From Annual Financial Reports)

Meet the requirements of its Operating License

Operate at least as efficiently as any comparable business

Maximize the net worth of the State’s investment in the corporation

Be a socially responsible member of the community it serves, and

Protect the environment by conducting operations in compliance with the requirements of the State’s environmental legislation and the principles of ecologically sustainable development.

Hunter Water - Statement of Corporate Intent

“To maintain and operate, at minimum overall cost a system of assets which provides the operating capability to deliver water, wastewater and stormwater drainage services of the specified quantity, quality and reliability

To acquire, as necessary and at minimum cost, new assets to provide essential improvements or financially viable expansion of the corporation’s operating capability”

Hunter Water - Statement of Corporate Intent (Assets)

The bottom line is that Hunter Water clearly believes the management of the systems assets is the primary job and manages information and decision making processes across maintenance, renewal and replacement strategies to drive toward least life cycle cost scenarios.

In less than a decade, changes in financial reporting (GASB 34) will bring us toward the same optimization models in our water industry

Hunter Water -

Hunter Water went from 1500 employees to 450 in a decadeIn addition, about 100 of their employees work for a subsidiary, that provides serves to Hunter Water and earns external income from other utilities by providing a range of operating / consulting type service to other smaller utilities They formed another subsidiary company for telemetry service and then sold that company for revenue for reinvestment in the base systemSince 1990, their audited average operating costs per service have fallen by over 40% in real termsOver the last decade average charges per customer were reduced by about 30% in real terms.The price reductions occurred during the same period when improved service standards were adopted and customer satisfaction surveys document improved customer satisfaction with service levels

12 of 21 wastewater treatment plants achieved full compliance with all license conditions. The other 9 plants achieved 99.6% compliance

Hunter Water How well are they doing?

Sydney Water has around 4,000 employees

800 employees are engaged in Asset Management activities

All of the operating, maintenance and capital cost come from fees from users & developers

In addition, Sydney pays $200 million a year to NSW as dividends, $28 million in Load Based Fees and $5 million in administrative fees

Their user fees are comparable to ours

They receive around $60 million for community service obligations from NSW for service to pensioners

Sydney Water

Sydney WaterSydney Water

Whenever possible work is competed

Bench marking is huge

The IPART (economic regulator) is responsible for assuring that the price structure reflects economic reward for best practice

New South Wales

About the same size as Utah

4.4 million people - - 3.1 in Melbourne

In 1982 about 450 utilities

Today 18 water and wastewater utilities

Criteria must have about $10 million in Revenues

Scale and size adequate to provide service in a professional manner

Amazing Facts

Within five years there will be no discharges from facilities

Even some rural utilities have ISO 14000 certifications

Victoria

VictoriaVictoria

Victoria - Service to a rural Area

About twice the size of Texas

Around 3 million people - - 1.3 in Brisbane

Utilities are managed at local level, about 225 providers

Used a very different approach to comply with the COAG

The local governments own the utilities, but they are setting them up just like the State owned corporations and plan on receiving dividends the same as NSW or Victoria

The Queensland approach is a local government reform model

Queensland

Developer Fees 1. Can you provide service to a site at

oak hill for 200 homes

2. Yes we can, it will cost you $___ and another $___ for

existing head worksinvestments

3. As soon as we get your check we will

proceed and service willbe available by ___

4. City Council, I have a commitment from the

water board to serve the site. I would like

zoning approval.

Load based fees are a new innovation in NSW

To give a sense of the framework

( the next couple of slides are pulled from a NSW EPA presentation)

For more detail Look at:www.epa.nsw.gov.au/licensing

Load based fees

Multi - Media across air, land & water emissions

Equally applied across all industry segments

You pay the same for discharging a pound of a regulated pollutant across all industries

A very user friendly on-line system is available to help you understand your fee obligations and your options

Load based fees

LBL fee structure

Annual PollutionloadLoad

limit

Fee RateThreshold

Adminfee

Pollutionload fee

Fee ($)

ExceedenceLevel -

Prosecutable

Portion of load attracting rebates

Load Reduction Agreements

Actual/weighted load

Loa

d (

fee)

Year 1 Year 2 Year 3 Year 4

Agreed load

Time

Load limit

Set the policy direction toward major changes in the industry

Brought resources to bear in support of the reform agenda

Provided financial incentives in the form of transfer payments to the State and local providers that proceeded with the changes

Established financial incentives, frequently in the form of debt for equity swaps, where the State took over existing debt service payments to give the new organizations a clean balance sheet on which to build their water business

The government arranged for Community Service Obligation payments (CSO) to address affordability issues of pensioners

The government supported a more aggressive R&D investment

The government played a significant role in bring about water reforms

This is quite a different paradigm from our current vision of how to best get the job done. Some of the ideas have transfer application, some may not

The set of ideas have an inter-locking character, which is important to framing a comprehensive vision of integrated changes

The Australian reforms prove that you can achieve substantial productivity gains, even in a well run industry, if you are willing to make structural changes and support the investments necessary to capture the productivity gain

Change of this magnitude requires that all the interest are party to the reforms, so the regulators would need to be party to the changing paradigm and new regulatory arrangements, such as an economic regulator, would need to evolve.

Could we do the same thing?

The business-like model under public ownership is very interesting

We are a much larger industry with a lot more players and for that reason more complexity. Comparable change would be very difficult.

Their arrangements are very rational models of how to manage to optimal service levels

Right now, their fees for service are very similar to oursMy view is that in the out years their approach offers a

competitive advantage over our current approach. They are better structured then we are to meet the upcoming challenges of renewing an aging systems and meeting new performance demands.

I think the growing demands, the competition for resources and the upcoming changes in how we keep our financial books, will lead us in a similar direction. It is a different paradigm, but an understandable vision.

In closing

Appendix C

Case Studies

Using the Nessie Approach

There were a number of major waves of development

in the last century and the composite of the data for

several areas starts to suggests a general profile

The bulk of the assets put in place in the last century have

very long lives.

Funding of replacement needs on a large scale is new to our

experience.

Chicago

0

500

1000

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2000

2500

3000

3500

4000

PO

P (

00

0's

)

Philadelphia

0

500

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2500

3000

3500

4000

PO

P (

00

0's

)Dallas

0

500

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1500

2000

2500

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3500

4000

PO

P (

00

0's

)

In the sample of utilities studied by AWWA, the average utility will see a three-fold increase in repair costs in the year 2020 despite sustaining a four-fold increase in replacement investment over today’s levels.

Demographics will produce the replacement and repair schedules in many major cities. However, every city has a unique demographic history and therefore a different set of challenges going forward.

An example of a “Nessie Curve” of relative asset replacement projections

2000 2020 2040 2060 2072

Water Supply Plant

All Water Mains

Wastewater Plants

All Sewers

The water and sewer mains present a gradually increasing

expenditure ramp.

Future expenditures for plant assets are more variable

(lumpy), reflecting their more intensive investment demands.

Treatment replacement or advanced treatment, will have to come on top

of the increasing ramp up of replacement costs for mains

The maintenance costs will continue to rise at the same time

replacement costs continue to grow.

The increased replacement funding needs, together with the increased maintenance funding needs, provides a

comprehensive understanding of the total cash flow

requirements

The per capita and per household costs

projected for Columbus are at the lower end of the range of utilities

Looking at the water and wastewater mains

separately confirms that they are both gradually

increasing ramps.

The water and wastewater plants have the shorter

replacement cycles and are lumpier

patterns

. Every utility has a set of challenges in asset

management stemming from the unique demographic and

historical factors

A few years ago Gloucester was faced with the need to opt for a decentralized treatment

technology -- in part of its service area. Unfortunately, the system has a short useful life, requiring replacement about

every 10 years

The chosen technology impacts per capita and per household costs. In older cities, where there has been a decline in population the replacement burden will fall very heavily on those

who remain.