Private Capital very often has a bad rap in the Water Sector. It is indeed hard for many to overcome the misconception that water has to be free. Yet if everyone is in his full rights to run around with a bucket and freely collect rainwater; sourcing, treating, conveying, managing, and reclaiming the water that feeds America and its economy has a cost and a (tremendous) value. So, how can private capital help solve the broken economics that makes for the Water Crisis in America?
Key Learnings:
Getting America’s broken water economics back on track is beyond the capacity of any of the economic sources individually. Hence, the solution will have to come from a blend of various sources.
- Federal money, in line with the $111 Billion Infrastructure investment, but not limited to it as it barely covers one-fourth of the immediate funding needs, one-tenth for the long term.
- Private-Public Partnerships to leverage the private sector’s capital and know-how together with the public sector’s frame.
- Private investment in water, probably beyond today’s 15% ownership, and conditioned to the ability to become profitable as an economic field to guarantee long-term sustainability.
- Philanthropic investments, blended with others, to build the perfect equilibrium that generates impact in the long run.
Table of contents
How to Fix Water’s Broken Economics?
Let me spit that out:
- Water is a profitable investment field.
- Private money can do great things.
- When rightfully oriented, it is a sure win-win.
And yes, I know, affirming that from downtown Manhattan can awaken ghosts of a time when all the above was proven wrong.
New York’s dramatic experience with private capital’s involvement in water
New York has long been infamous for being a city that had everything but water. From its early Dutch times to its British history all the way to its first sixty years of American independence, Big Apple didn’t have any reliable source to draw its water from.
And while Philadelphia would strive as a result of a collective effort to bring pure water into everyone’s home, New York fell victim to some high elite’s greed, biased policy, and misuse of capital.
That would hamper the city’s effort to get water, indirectly cost millions in devastating fires, and significantly impact its population several times through water-based epidemics.
I’ve already shortly mentioned the culprits in the previous chapter: Aaron Burr, Alexander Hamilton, and a bunch of their acquaintances.
The infamous “Manhattan Company” that became one of the most successful banks in the World
Just before the turn of the 19th century, they created the “Manhattan Company,” a group with broad rights and few obligations. Under the false nose of supplying the city with “pure and wholesome water,” it leveraged a “surplus capital” clause which, indeed, allowed it to become… a bank.
Over the decades of its “water business,” the Manhattan Company barely crossed financial breakeven, which was already a significant accomplishment, as they had no real durable access to a water source.
Making money selling water without water? That was possible with a simple trick: not investing in a water network either. The rest is banking history, and it was proven to be incredibly profitable!
Bottom line: it’s only when New York decided to make the water topic a public one again that it finally got its first safe water deliveries from the Croton Watershed.
Private Capital and Water Policies have to work hand in hand
Is that proof that nothing positive can result from private capital’s involvement in water? Thankfully, not at all.
Had the Manhattan Company not been created by Senators, General Attorneys, and future Vice-Presidents, it would probably not have been able to distort policies thus far.
The real lesson to remember here is that Water Economics and Water Policies are a powerful duo that has to work hand in hand. Something Tom Rooney illustrates with a race car analogy:
So how do you develop that immense horsepower? Actually, it starts with finding the right blend.
Blending Capital
When you think of it, if handled right, tap water has a strong value proposition:
You know that: in marketing terms, a strong value proposition leads to a good market share, great service, happy customers, and, ultimately, profit.
Now, that path isn’t always so straightforward: you REALLY have to handle water right. And to do so, you need to rightfully invest twice.
Water Infrastructure is an expensive investment
First, by laying down the appropriated infrastructure. In most US cases, this was done a while ago, yet, appropriately revamping that said infrastructure is equally important.
(and when infrastructure doesn’t exist yet, other approaches might be more effective – but that’s a story I’ll keep for later)
The problem is that this means a lot of money to sink in upfront, especially when you’re a relatively small community.
The trap, though, is that under-investing ultimately results in even higher costs, so counterintuitively, no one should be rich enough to go cheap.
Indeed, that’s the second investment: allocating reasonable operating costs to run your system over time efficiently. The secret? A compound of maintenance effort and infrastructure management.
As a result, the key to success in that endeavor is a matter of scale. It would be best if you had deep pockets upfront and the soundest know-how all the way after that. Two characteristics that appeal to the private sector.
Levering Private Capital in America’s Water
Private money’s involvement in Water isn’t all new in the US as Henry Cordes recalls:
A good portion of these private water utilities are on the smaller end or even operated as a side business of a different industry. And for long, it had consequences, as Josiah Cox tells us.
The example of Central States Water Resources
This private sector’s involvement would take the shape of CSWR Josiah Fox created in 2014.
Interestingly, CSWR has been regularly topping the M&A leaderboard in the number of deals in the year… but never in the number of connections or customers. There’s a simple reason: the company focuses on small, distressed, non-compliant plants.
That’s where actually the flip is the most effective – it enables a consolidator to unlock a scale effect among a scattered cluster of systems (and we’ll see in Chapter 3 how that approach may do well in the long run).
And as it takes a losing situation – bad water in the wrong hands – to turn it into a win-win – good water at a profit – it sounds like a no-brainer positive move.
So, for the 15% already private utilities, there’s a clear success path in realizing Seth Siegel‘s plea: consolidating them into distributed giants powered by private money.
But what about the other 85%?
The tremendous Capital Need in Water
The US EPA estimates that they will need to invest $470 Billion in the next 20 years to keep the water quality afloat. And according to Damian Georgino:
Needless to say, public investment programs don’t match those numbers. In 2021, the Biden-Harris administration announced the unlocking of $111 billion. That was historic, unprecedented… yet far from being enough.
Could the missing investment come from Private Capital?
Succeeding in that endeavor may require breaking a taboo in the US:
A way forward will be about finding the right blend of private and public capital, or said differently; it will be about Private Public Partnerships.
Will these PPP players still be the same as the private consolidators?
If CSWR was to enter this new extension of the game, it would get backing from its current investor:
But aside from private consolidators, that new approach will also require the involvement of new players.
New PPP players will have to enter the game
Patrick Decker, the CEO of Xylem, is clear:
This partnership can come in many shapes, but the conventional approach is to have a private company financing upfront an infrastructure asset against a revenue-based contract that repays it over time – typically 15 to 30 years.
New Project Structures for reinforced efficiency
Before the popularization of PPPs, a public body designed a new water infrastructure, with private companies then bidding on it, building it, and transferring it.
According to “Public Works Financing” research, adopting Design-Build approaches, where private companies were allowed to submit their own designs, enabled the US Water sector to save 39% on capital.
Adding a third initial to the acronym with Design-Build-Operate enabled a further 26% reduction in life cycle cost!
Hence, when a public body enters into a private-public partnership, it unlocks the benefits of this private sector’s involvement minus the profit the private company is planning on over the contract.
Well-balanced PPPs are a clear asset
This is why even the United Nations have been promoting the PPP approach, assuming it would follow some best practices, such as the fair sharing of risks and rewards – aka no extreme risk transfer or profit.
And it is not the only merit of Private Public Partnerships according to Errick Simmons:
… especially when private capital alleviates the burden on mayors
Another perk of the PPP approach is that a municipality avoids cashing out upfront, a perk for James Rees:
Now let’s face it: PPPs also come with a bad rap. The mechanism may have been overused in the 1990s on projects that were probably too broad and left a lot of space for the “reckless manners” James alluded to.
Private Public Partnerships need to be better used than they were in the 1990s
These successes have led PPPs to jump by a 146% increase between 2020 and 2021 in the Water and Sanitation sector worldwide.
Another sign that the tool, when used right, is a clear asset in water management’s toolbox.
… and they still won’t solve the World alone
Now, as promising as the private consolidation and the private-public partnership paths may be, they won’t solve the world alone.
Sarah Kapnick actually doubles down:
This is where a third mechanism comes into play: government funding.
Increased Government Funding in Water
This speaks to the dichotomy I was alluding to earlier: we need one trillion dollars, and we get a historic yet insufficient 111 billion.
But why should more money come from the governments when I earlier demonstrated that investing in water was profitable? Why wouldn’t private infrastructure funds foot the bill?
It’s actually a matter of wrong pocket.
Unlike private capital, Governments have the power to overcome the wrong pocket problem
If you remember, George McGraw already introduced the concept in our first chapter:
On the other end, more state money would push us into the next challenge.
Large vs Small projects
Federal infrastructure or inflation regulation plans naturally call for large projects when the appropriate scale might be different, as Kevin Sofen underlines:
In short: we will need more federal funding as that’s the level where the windfalls will be collected.
Extracting the most out of public investment in water
But we then also need the entire value chain to transfer as much power as possible from the engine to the wheels:
That way, we will avoid the famous pitfall Reinhard Hübner expressed on my podcast microphone: having “too much stupid money chasing too few good projects.”
But before we wrap up this chapter, we have to address one more pocket of money.
3 Pockets of money – aren’t we forgetting one?
We’ve seen:
- how private money can do well in consolidating private assets.
- how private money, technology, and know-how can join forces with public bodies to build successful partnerships
- how, eventually, we’ll need more federal investment
Yet, there’s a fast track to efficiency that can put the rollout of these solutions on steroids:
Philanthropic Capital
Philanthropy has that incredible feature: it is meant to be “lost.”
Yet, I’d bet donors wouldn’t complain if that money were to achieve a maximized impact!
That’s where players like Merton Capital Partners play a new role, as Sean Davis underlines:
The keyword here is blend. A fraction of sunk philanthropic capital in the broader blend of for-profit private money and public funds can make a deal profitable, hence getting all the parties to agree on it.
Where can philanthropic capital blend with private and public funds the best?
Two water areas Merton has been looking into so far are the 5’000 abandoned water utilities that ran out of money and contributed to the 44 million Americans that got exposed to safe-drinking water act violations and the coastal wastewater treatment plants (or rather, the absence of it).
For that to happen, there’s a last hurdle to overcome:
So this time, it boils down to spreading the right messages and educating the general public about the water challenges, something we’ll cover in Chapter 4.
For now, having hopefully covered how we will solve water’s broken economics, it’s time to establish the right level and scale to tackle our broken pipes problem. And that’s next!