Water Utility Financial Risk

Water utilities typically attempt to recover their costs – dominated by large, fixed payments for things like debt service and infrastructure maintenance – with revenue from the volumetric sale of water.  Water rates are set at levels to achieve revenue targets based on annual demand projections.  This process is highly regulated in most regions and cannot be easily changed if water consumption deviates from these projections.  As utilities begin to include more adaptive management techniques – either through drought-time demand restrictions or access to auxiliary sources – new sources of financial risk are introduced to a historically stable budgetary model.  Depressed revenues due to use restrictions or the additional costs of accessing auxiliary sources can eat into a utility’s budget, often causing them to forgo scheduled maintenance or other improvements.  This has the potential to start a downward spiral – drought-related costs causing a lack of investment in existing infrastructure, leading to more susceptibility to drought, leading to less investment in infrastructure, leading to…….

Utilities can prepare for these financial risks by building ‘ contingency funds’ dedicated to maintaining revenue stability during drought.  However, utilities walk a fine line when deciding how large these funds need to/should be.  Too small, and they leave themselves open to the risk of long, drawn out drought events or a series of smaller droughts.  Too large, and large sums of money, much of which could sit around unused for many years, could be subject to ‘raiding’ by other cash-strapped agencies within local government or could potentially violate existing bond covenants.  To help utilities avoid some of these pitfalls, we have done some work developing ‘index insurance’ contracts based on reservoir inflows, similar to those based on heating/cooling degree days used in the energy industry. When certain streamflow conditions, correlated to the imposition of use restrictions and/or costs of tapping auxiliary supplies, occur, contracts are designed to payout. A third party would clearly charge more than the expected value of the contract payouts (essentially charging to acquire the risk), but for risk premiums in the range of 20-30%, we have shown that third-party index insurance contracts can be used to reduce the costs of mitigating these types of financial risks for water utilities.

Tradeoffs in water supply portfolio development

The growing environmental and financial burdens of new storage infrastructure have led many water utilities to develop alternative water management strategies that utilize demand reduction and regional cooperation to maximize the efficiency of their existing supplies.  While these strategies can be greatly beneficial to water utilities, they also introduce complexity into the planning process.  Decision making must be performed with the consideration of a wide range of objectives from multiple actors.  Identifying relevant tradeoffs between these objectives and visualizing how they are improved through different options available to utilities will be valuable as management strategies become more complex.

Four water utilities in the ‘Research Triangle’ region of North Carolina are attempting to develop a coordinated regional water supply plan that takes into account the very limited potential to develop new supply sources in the immediate future (through 2025).  Aided by the use of state-of-the-art multiobjective evolutionary algorithms (MOEAs), we show how planning options like regional water transfers and the use of third-party index insurance contracts can move the region closer to a pre-ordained set of management objectives.