Rebuilding California’s Infrastructure – Water Reuse (Part 2 of 6)

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This is Part Two of “Rebuilding California’s Infrastructure,” to access the other five sections, click on the links below. To access the entire six-part study in a single, printable PDF document, DOWNLOAD HERE.

Part One: Introduction
Part Two: Water Reuse
Part Three: Water Storage
Part Four: Desalination
Part Five: Energy and Transportation
Part Six: Financing Models and Policy Recommendations

WATER REUSE

While water reclamation, or more commonly, water reuse, has been used primarily to achieve conservation goals, we examine its potential to increase water supply and to generate revenue. We will explore how water authorities[1] could use reclaimed water as a new source of revenue to accelerate efforts to build facilities and acquire greater water reuse capacity. We will also examine how this revenue could be used to repay taxpayers and investors committing capital to water reuse projects.

Water reclamation—the treatment of wastewater to produce water that meets increasing standards of water quality, specifically, non-potable reuse (NPR), indirect potable reuse (IPR), and direct potable reuse (DPR)—introduces new revenue potential to the business models of municipal water authorities and promises to expand water markets across California.

The table below describes the three categories of reclaimed water in terms of fundamental approved use as determined by progressively stricter water quality standards. The table also highlights dynamics fueling market activity.

Types of Reclaimed Water, Use and Market Dynamics
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The convergence of these market dynamics is driving the market for reclaimed water, particularly in local water markets where traditional suppliers are not able to meet demand and consumers’ tolerance for continued forbearance with conservation mandates and supply disruptions wanes. As we will show, there is a tension between policymakers’ efforts to encourage water recycling for conservation purposes and long-standing regulations that make it difficult for water authorities to finance such capital-intensive mandates.

According to California’s Department of Water Resources (DWR), recycled water has the potential to increase water supply by 1.8 million to 2.3 million acre-feet per year by 2030.[2] In 2013, DWR reported annual water reuse production of 670,000 acre-feet.[3] Applying current local rates of $208 per acre-foot for recycled water[4] and recent open market price observations of $1,000 per acre-foot[5] the midpoint of DWR’s 2030 projection levels would indicate a $426 million regulated-market value or a $2 billion value on the open market (although such a large increase in the amount of water available could lead to lower prices).

CURRENT CAPACITY

California continues to lead the country in water reclamation and was the first state to establish regulations for non-potable reuse. Water reclamation plants in California have been treating wastewater to produce non-potable water for irrigation and other commercial purposes since the mid-sixties. Today, there are roughly 250 water reclamation facilities statewide. The most recent survey of water reuse found that approximately 13 percent (or 669,000 acre-feet) of the total 5 million acre-feet of municipal wastewater produced each year is reused.[6]

We estimate the annual cost to treat California’s wastewater is more than $3.6 billion.[7] The water that is treated but not reused—some 4.3 million acre-feet—is then disposed of on an annual basis. With water selling for $1,000 per acre-foot on the open market, the value of this discarded water is about $4.3 billion per year, before treatment costs.

While most of California’s reclaimed water is for non-potable reuse, some water districts began acquiring advanced water purification technology to produce indirect potable water for recharging and/or replenishing groundwater beginning in the early 2000s. According to the Department of Water Resources, IPR production represents approximately 19% of wastewater reclaimed.[8] A few water districts have upgraded (or are considering upgrading) their advanced water purification facilities to be able to produce drinking-quality water (DPR) as policymakers work to establish quality standards.

To put California’s capacity to reuse water into context, we compare current and state-targeted levels for 2030 to total wastewater volume available in the chart below.

California Wastewater Volume – Current vs. Potential Capacity
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Local water districts are keenly interested in increasing water reuse capacity because of 1) uncertainty about the reliability of existing water supplies, 2) rising costs to import water, and 3) state policy guidelines on wastewater discharge requirements.  As they begin to produce more meaningful supplies of potable and non-potable water revenue potential increases, cost-saving opportunities emerge, and new customer segments develop.

Key legislation has encouraged water authorities to increase water reuse capacity and to study the feasibility of developing greater potable reuse capacity. At the same time however existing legislation such as Proposition 218, restricts water authorities’ ability to develop reuse capacity by requiring fees to be tied directly to services of a specific asset.

Examples of water reuse projects under development include the Montebello Forebay Groundwater Recharge Project, Orange County Water District’s Groundwater Replenishment Program, Eastern Municipal Water District’s Potable Reuse Program, San Diego Water Purification Project, Santa Clara Valley Water District’s IPR projects, with similar initiatives underway in Long Beach, El Segundo, and Chino.

COSTS TO BUILD WATER REUSE CAPACITY

A landmark study of water strategies designed to increase supply included an analysis of water reuse projects. Researchers calculated the cost of a representative recycling project with the capacity to produce both non-potable reuse and indirect potable reuse at $1,000 per acre-foot on an all-in basis over 30 years. This finding was based on capital costs of $480 million, annual operating costs of $30 million, and a yield of 72,000 acre-feet.[9]

The study’s methodology drew on three key variables—capital cost (cost to build), operating cost (annual cost to operate), and yield (the volume of water supplied)—and then factored in assumed debt financing costs over 30 years at 5 percent and some other qualitative metrics. The total annual cost was then divided by the project‘s yield per year to determine the all-in (unit) cost per acre-foot of water sourced from the project over the next 30 years.

As a comparison, the study calculated a $350 per acre-feet cost for a much smaller project producing a fifth of the volume—13,700 acre-feet per year—in a facility that cost only $49 million to build. The facility, however, was dependent on existing infrastructure for operational support and did not have the capacity to produce indirect potable reuse. This illustrates the challenge in evaluating the cost to acquire water reuse capacity, which varies widely due to the import of both project-specific and site-specific factors.

In the table below, financial information from proposed and completed projects provides additional perspective on cost variability in acquiring potable and non-potable water reuse capacity.

California Water Reuse Projects: Completed and Proposed
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Our analysis finds that multiple factors impact the cost of water reuse projects in both potable and non-potable strategies. These factors include the condition of the existing water treatment infrastructure, quality of the source water, treatment process methodology, conveyance requirements, storage needs, energy provisions, location complexities such as proximity to source and discharge points, environmental buffer suitability, and financing costs.

Recent estimates for proposed projects provide further evidence of the variability in the cost to produce water for reuse, which range from $300 to more than $1,300 per acre-foot.[10] The cost of reclaiming water is generally expected to continue to decline as emerging technologies improve the efficiency of treatment process and reduce energy requirements. Costs will fall further as water authorities progress from pursuing non-potable and indirect potable reuse capacity to acquiring direct potable reuse capacity.

REVENUE POTENTIAL

In addition to increasing water supply, water reuse introduces new sources of revenue to water authorities. This presents an opportunity for water managers to monetize wastewater treatment operations and the associated end products—i.e., non-potable and potable reuse—in ways that create value for ratepayers and potential investors. Key to realizing this opportunity is in pricing the new supply to better tie to the full cost of production and to market demand for water. Doing so will have the added benefit of opening California’s water markets to private investors.

By creating revenue streams from what otherwise would have been operational costs, municipal water authorities can adapt their cost-recovery mandates to become more profitable stewards going forward. Water districts spend over $850 per acre-foot to treat and dispose of wastewater while potential buyers are eagerly paying nearly $1,000 per acre-foot whenever scarce opportunities to purchase water appear.[11] Moreover, after incurring the cost of treating and disposing wastewater, water districts in many parts of California then spend over $750 per acre-foot to import water to satisfy customer needs.[12]

This translates into the opportunity to both reduce costs—potentially covering water treatment costs and eliminating imported water costs—and to earn revenue by selling excess capacity.

Capitalizing on the revenue potential of water reuse benefits water districts, ratepayers, and policymakers. New revenue streams strengthen the water district’s balance sheet and business model, easing the reliance on traditional debt financing. Tapping into new market segments diversifies the customer base, reducing the need for rate hikes and fee levies. Modernizing wastewater treatment operations with revenue-generating assets enhances the ability of water districts to comply with climate and conservation policy goals.

Current commercial opportunities for water managers include selling excess supplies of potable and non-potable reuse to 1) industrial businesses vying for more aligned pricing, 2) water districts seeking to replenish groundwater, augment surface water supply, and/or mitigate seawater barrier intrusion, and 3) agricultural concerns experiencing reduced allocations from water authorities.

Farmers are a good example of a new customer segment for water operators. Historically, the cost to convey water from urban water operators to farmers has been prohibitive. But recent water allocation policy decisions have left some farmers without enough water to irrigate their crops forcing them to let fields lie fallow. For these potential customers, making the capital investment necessary to establish water delivery channels from urban water facilities increasingly makes sense.

RETURN ON INVESTMENT

There are few, if any, private sector investments in California’s civil water reclamation assets or water reuse projects over the past twenty-five years.  Consequently, no investment-return data is available for analysis.

The market for recycled water in California is evolving as policymakers and ratepayers consider the long-term implications of water scarcity. In so doing, many are recognizing that water and wastewater services are a much more complex and capital-intensive proposition than selling a public good.

Similarly, the validity of the water sector’s cost recovery model has been called into question as concerns about water quality and supply issues, outdated infrastructure, deferred maintenance, climate change, and contaminants loom larger than the billions already borrowed to comply with regulatory-mandated remediation.[13]

Current pricing policies are challenging all constituencies as operations and maintenance costs rise and water sales revenue falls. Water pricing policies and municipal financing practices reveal often fail to fully capture the lifecycle costs of water delivery and wastewater treatment, further compromising the financial stability of water authorities.[14]

The convergence of these dynamics presents an opportunity for private investors to partner with municipal water authorities to unlock value in new revenue-generating services such as water reuse. Few water authorities can take the financial risks of building new infrastructure to deliver recycled water to customers or investing in emergent water purification technologies to lower costs. For private investors, these risks present an investment opportunity.

As the costs of public financing increase—whether due to using bonding capacity for projects that could otherwise be financed by the private sector or to investing in sub-optimal technologies because better alternatives are unproven and carry higher risk—the price of private financing becomes more attractive given the value created for the public. Moreover, these uncaptured values reveal the true cost of public financing especially when the impact of subsidized bond financing on market pricing is factored into decision-making. Returns for private investors can be captured in the value they offer water authorities that is not available from the capital markets and reduces uncompensated risks borne by taxpayers.

By partnering with the private sector to take risks that are not appropriate for the public sector, water authorities can offset the costs of water reuse capacity and increase water supply to Californians.

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FOOTNOTES

[1] Public sector water providers are often special districts or authorities. They may also be part of a municipal government. We will use the term “water authorities” to refer to all types of government entities that supply water either on a wholesale or retail basis.

[2] California Department of Water Resources (2013). California Water Plan Update 2013, Vol. 3, Chapter 1, Introduction, p. 1-9. http://www.water.ca.gov/waterplan/docs/cwpu2013/Final/Vol3_Ch01_Introduction.pdf.

[3] California Department of Water Resources (2013). California Water Plan Update 2013, Vol. 3, Chapter 12, Municipal Recycled Water, p. 12-11. http://www.water.ca.gov/waterplan/docs/cwpu2013/Final/Vol3_Ch12_Municpal-Recycled-Water.pdf.

[4] This is an average of current rates for recycled water reported in the 2015 Comprehensive Annual Financial Reports of the Eastern Municipal Water District (p. 97), the Orange County Water District (p. 63), and the Santa Clara Valley Water District (p. 141).

[5] See for example, Keith Schneider’s interview with Anthea Hansen, Del Puerto Water District manager in “One Way to Ease California Drought: Recycle Wastewater For Irrigation,” Circle of Blue, July 23, 2015, available at http://www.circleofblue.org/2015/world/one-way-to-ease-california-drought-recycle-wastewater-for-irrigation/ and Ryan Bradley’s interview with Earle Hartling, Recycling Coordinator for the Metropolitan Sanitation District in “To Fight the Drought, California Is Turning Sewage Into Drinking Water,” Take Part, December 8, 2015, available at http://www.takepart.com/article/2015/12/08/recycled-water.

[6] See State Water Resources Control Board and Department of Water Resources 2012 staff report. Results, Challenges, and Future Approaches to California’s Municipal Wastewater Recycling Survey (2009), p.1 available at http://waterboards.ca.gov/water_issues/programs/grants_loans/water_recycling/docs/article.pdf..

[7] This calculation uses an average cost of $721/AF to treat California’s wastewater [based on sewer operations costs and wastewater treated volumes reported in the 2015 Comprehensive Annual Financial Reports of the Eastern Municipal Wastewater District (p.29 and p.92), the Irvine Ranch Water District (p.95 and p.97) and the San Francisco Public Utilities Commission, (p.147 and p.221)] and applies it to the 5 million acre-feet of treated wastewater produced annually statewide as estimated in State Water Resources Control Board and Department of Water Resources 2012 staff report, Results, Challenges, and Future Approaches to California’s Municipal Wastewater Recycling Survey,p.1 available at http://waterboards.ca.gov/water_issues/programs/grants_loans/water_recycling/docs/article.pdf).

[8] State Water Resources Control Board and Department of Water Resources 2012 staff report, Results, Challenges, and Future Approaches to California’s Municipal Wastewater Recycling Survey (2009), p.7, available at http://waterboards.ca.gov/water_issues/programs/grants_loans/water_recycling/docs/article.pdf.

[9] Gregory Freeman, Myasnik Poghosyan, and Matthew Lee (2009). Where Will We Get the Water?
 Assessing Southern California’s Future Water Strategies. Los Angeles County Economic Development Corporation. http://www.laedc.org/reports/WhereWillWeGettheWater.pdf.

[10] California Department of Water Resources (2013). California Water Plan Update 2013, Vol. 3, Chapter 1, Introduction p. 1-12. http://www.water.ca.gov/waterplan/docs/cwpu2013/Final/Vol3_Ch12_Municpal-Recycled-Water.pdf.

[11] For example, in 2015 the Del Puerto Water District purchased 44,000 acre-feet of water from rice growers in northern California at $850 per acre-foot and 13,000 acre-feet from Merced County at $950 per acre-foot. Keith Schneider (July 23, 2015). One Way to Ease California Drought: Recycle Wastewater for Irrigation. Circle of Blue. http://www.circleofblue.org/2015/world/one-way-to-ease-california-drought-recycle-wastewater-for-irrigation/.

[12] The Irvine Ranch Water District currently reports a cost of $1,000 per acre-foot for imported water on its website. This compares to reported costs in 2015 of $1,424 per acre-foot by the Padre Dam Municipal Water District and $794 per acre-foot by the Santa Monica Water District. See also the Eastern Municipal Water District and Orange County Water District 2015 Comprehensive Annual Reports.

[13] Jarmo Hukka and Tapio Katko (2015). Appropriate Pricing Policy Needed Worldwide for Improving Water Services Infrastructure. Journal – American Water Works Association. Volume 107 Number 1. Pages E37-E46. http://www.awwa.org/publications/journal-awwa/abstract/articleid/48268706.aspx.

[14] Johnson Foundation at Wingspread (January 2012). Financing Sustainable Water Infrastructure. http://www.johnsonfdn.org/sites/default/files/reports_publications/WaterInfrastructure.pdf.

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ABOUT THE AUTHORS

Marc Joffe is the Director of Policy Research at the California Policy Center. In 2011, Joffe founded Public Sector Credit Solutions to educate policymakers, investors and citizens about government credit risk. His research has been published by the California State Treasurer’s Office, the Mercatus Center at George Mason University, the Reason Foundation, the Haas Institute for a Fair and Inclusive Society at UC Berkeley and the Macdonald-Laurier Institute among others. He is also a regular contributor to The Fiscal Times. Prior to starting PSCS, Marc was a Senior Director at Moody’s Analytics. He has an MBA from New York University and an MPA from San Francisco State University.

Jill Eicher Jill Eicher is a researcher focusing on innovative financing models for public-sector agencies. Most recently, she was a Visiting Scholar at Stanford University’s Global Projects Center, working on the development of a cooperative investment model for public pension funds to deploy capital into U.S. infrastructure. She co-founded the Fiduciary Infrastructure Initiative, a research-driven venture focused on the applicability of international pension cooperatives making direct infrastructure investments as models for the U.S. A graduate of Wellesley College, Eicher did post-graduate work in mathematics and was issued a patent for her method for assessing investment risk.

Ed Ring is the Vice President of Policy Research at the California Policy Center. His work has been cited in the Los Angeles Times, Sacramento Bee, Wall Street Journal, Forbes, and other national and regional publications. Previously, as a CFO primarily for start-up companies in the Silicon Valley, he has done financial accounting for over 20 years, and brings this experience to his analysis and commentary on issues of public sector finance. From 1995 to 2009 he was the editor of EcoWorld, a website covering environmental issues from a free-market perspective. Between 2007 and 2010 he launched in partnership with AlwaysOn Media the highly successful “GoingGreen” clean technology investor conferences, held annually in San Francisco and Boston. He has an MBA in Finance from the University of Southern California, and a BA in Political Science from UC Davis.

Kevin Dayton is a policy analyst for the California Policy Center, a prolific writer, and the author of frequent postings about generally unreported California state and local policy issues on the California Policy Center’s Prosperity Forum and Union Watch. Major policy reports written by Kevin Dayton include For the Kids: California Voters Must Become Wary of Borrowing Billions More from Wealthy Investors for Educational Construction. Dayton spent more than 17 years in various federal, state, and local policy positions for Associated Builders and Contractors (ABC), including ABC of California State Government Affairs Director from 2005 to 2012. He was also a legislative assistant in the U.S. House of Representatives for Congressman Gary A. Franks (R-Connecticut) from 1992 through 1994. Dayton is a 1992 graduate of Yale University, where he majored in History.

ABOUT THE CALIFORNIA POLICY CENTER

The California Policy Center is a non-partisan public policy think tank providing information that elevates the public dialogue on vital issues facing Californians, with the goal of helping to foster constructive progress towards more equitable and sustainable management of California’s public institutions. Learn more at CaliforniaPolicyCenter.org.

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