The Clean Water and

Drinking Water Infrastructure

Gap Analysis
Office of Water (4606M)

EPA-816-R-02-020

www.epa.gov/safewater

September 2002 Printed on Recycled Paper

Message from EPA’s Assistant Administrator for Water

As our economy and population grow, we must

periodically take a good look at the challenges ahead

and reassess our nation’s needs for infrastructure to

ensure clean and safe water. By “infrastructure” we

mean the pipes, treatment plants and other critical

components that deliver safe drinking water to our

taps and remove waste water from our homes and

other buildings. Recognizing the importance of

having a common understanding of the challenges

ahead, the U.S. Environmental Protection Agency

(EPA) undertook a “Gap Analysis” to review the

historical patterns of infrastructure investment,

compare it to projections of future needs, and

provide a transparent assessment of the gap between

needs and spending. The result of our effort is this

report on the Clean Water and Drinking Water

Infrastructure Gap Analysis.

In keeping with our commitment to subject

our analysis to external scrutiny, EPA submitted the

methods and data used in the Gap Analysis to a

diverse panel of peer reviewers drawn from

academia, think tanks, consulting firms, and industry.

Overall, the reviewers commended the report as a

reasonable effort to quantify the gap. As a result of

the peer review process, we revised the preliminary

projections and approaches to incorporate the

comments and views of these expert external

reviewers.

This report makes clear that there is no single

correct number to describe the gap. Any gap study

must be built using methodologies and definitions of

need, which in turn rest on assumptions about the

present conditions of infrastructure nationwide, and

desirable or appropriate policies to follow in the

future. While much of the projected gap is the

product of deferred maintenance, inadequate capital

replacement, and a generally aging infrastructure, it is

in part a consequence of future trends we can

anticipate today, such as continuing population

growth and development pressures. Yet, funding

gaps need not be inevitable. They will occur only if

capital and operations and maintenance (O&M)

spending and practices remain unchanged from

present levels. The analysis suggests that a large gap

will result if the challenge posed by an aging

infrastructure network—a significant portion of

which is beginning to reach the end of its useful

life—is ignored.

EPA has encouraged a national dialogue on

the appropriate roles for addressing infrastructure

needs and continues to work in partnership with

Congress and other stakeholders in helping to define

effective approaches to meeting these emerging

challenges. This report on the Clean Water and

Drinking Water Infrastructure Gap Analysis is one of

EPA’s contributions toward an ongoing dialogue. Our

objective is to ensure clean and safe water for

generations to come. Water infrastructure is key to

that future.

G. Tracy Mehan, III
The Clean Water and

Drinking Water Infrastructure

Gap Analysis

United States

Environmental Protection Agency

Office of Water

(4606M)

EPA-816-R-02-020

September 2002

Printed on Recycled Paper

Table of Contents

Table of Contents

Introduction ................................................................................................................................................................................. 7

Characteristics of the Clean Water and Drinking Water Industries.......................................................................................................10

2.0 Purpose .............................................................................................................................................................................................10

2.1 Characteristics of the Clean Water Industry...............................................................................................................................10

2.2 Characteristics of the Drinking Water Industry.........................................................................................................................10

2.3 General Characteristics of Capital Stock and Impact on Operations and Maintenance .....................................................11

2.4 Clean Water Capital Stock .............................................................................................................................................................13

2.5 Drinking Water Capital Stock .......................................................................................................................................................15

2.6 Costs of Providing Service ...........................................................................................................................................................17

Methods for Estimating Needs and Spending for Clean Water .............................................................................................................19

3.0 Purpose .............................................................................................................................................................................................19

3.1 General Steps ...................................................................................................................................................................................19

3.2 The Clean Water Capital Need .....................................................................................................................................................19

3.3 Estimate Total O&M Needs .........................................................................................................................................................23

3.4 Estimate Current Spending ...........................................................................................................................................................25

3.5 Estimate the Total Payment Gap ..................................................................................................................................................25

3.6 No Revenue Growth and Revenue Growth Scenarios .............................................................................................................27

 3.7 Key Variables ...................................................................................................................................................................................28

Methods for Estimating Needs and Spending for Drinking Water .......................................................................................................29

4.0 Purpose .............................................................................................................................................................................................29

4.1 General Steps–Capital Needs ........................................................................................................................................................29

4.2 The Drinking Water Capital Investment Need ..........................................................................................................................30

4.3 Allocate Capital Investment Need by Year .................................................................................................................................35

4.4 Calculate Financing Costs..............................................................................................................................................................35

4.5 Estimate Current Spending ..........................................................................................................................................................36

4.6 Estimate the Total Capital Payment Gap ...................................................................................................................................38

4.7 Estimate the Operations and Maintenance (O&M) Gap ........................................................................................................39

Conclusion .......................................................................................................................................................................................................43

5.0 Findings ............................................................................................................................................................................................43

5.1 Suggestions for Future Research ..................................................................................................................................................43

Appendix A: Comparing the Gap between Clean Water and Drinking Water: Numbers and Methodologies ..............................45

1.0 Comparison between the Clean Water and Drinking Water Capital Payment Gap .............................................................45

1.1 Comparison between the Clean Water and Drinking Water O&M Payment Gap ...............................................................46

Appendix B: Critiques and Comments from the Peer Review Panel ....................................................................................................48

1.0 The Peer Review Process..............................................................................................................................................................48

1.1 Major Points about the Capital Estimates...................................................................................................................................48

1.2 Major Points about the O&M Estimates ....................................................................................................................................49

1.3 Major Points about the Financing Forecast ................................................................................................................................50
Figures and Tables

Figures and Tables

Figure 1–1: Increase in U.S. Population by Decade .......................................................................................................................... 8

Figure 1–2: Projection of Increase in Biological Chemical Oxygen Demand (BOD) ............................................................... 9

Figure 1–3: Declining Trend in R&D Water Pollution Abatement Expenditures....................................................................... 9

Figure 2–1: Percentage of Drinking Water Systems and Population Served by Size Class .....................................................10

Figure 2–2: Percentage of Drinking Water Systems by Type of Ownership .............................................................................11

Figure 2–3: Example of Life Cycle Deterioration Curve .............................................................................................................12

Figure 2–4: Operations and Maintenance Spending from State and Local Sources (1978–1994)..........................................12

Figure 2–5: 1996 Clean Water Needs by Category (adjusted for the SSO study)–$225 Billion in 2001 Dollars ................13

Figure 2–6: Histogram of Miles of Sanitary Sewer Pipe Installed per Decade.........................................................................14

Figure 2–7: Average Age of Wastewater Pipe Network ................................................................................................................14

Figure 2–8: Shift in the Likely Condition Associated with the Aging Miles of Pipe in the Network (percentage of

 pipe by classification) .....................................................................................................................................................15

Figure 2–9: Percent Needs by Drinking Water Infrastructure Category (total needs $150.9 billion) ....................................16

Figure 2–10: Age Distribution of Current Inventory of Pipe for 20 Cities .................................................................................16

Figure 2–11: Projected Annual Replacement Needs for Transmission Lines and Distribution Mains, 2000–2075 ..............17

Figure 2–12: Change in Distribution of User Fees for Communities in Ohio between 1989 and 1999 ................................17

Figure 2–13: Percentage Point Change in Share of Aggregate Income for Households ...........................................................18

Figure 3–1: Projected Capital Costs (Average Scenario) .................................................................................................................22

Figure 3–2: Projected Capital Payments (Average Scenario) ..........................................................................................................23

Figure 3–3: Annual Operations and Maintenance Cost Measured as a Percentage of Net Capital Stock

 (Average Scenario) .............................................................................................................................................................23

Figure 3–4: Projected O&M Payments (Average Scenario) ............................................................................................................24

Figure 3–5: Capital Payment Gap (Average No Revenue Growth Scenario) ..............................................................................24

Figure 3–6: Capital Payment Gap (Average Revenue Growth Scenario) .....................................................................................24

Figure 3–7: O&M Gap (Average No Revenue Growth Scenario) ................................................................................................25

Figure 3–8: O&M Gap (Average Revenue Growth Scenario) .......................................................................................................25

Figure 3–9: Cumulative Growth in Sewerage Expenditures and Gross Domestic Product 1980-1999 .................................27

Figure 3-10: A Qualitative Assessment of the Sensitivity of the Gap Estimate .........................................................................28

Figure 4–1: Pipe Replacement Model Replacement Need Estimate .............................................................................................34

Figure 4–2: Projected Drinking Water Capital Spending (adjusted for privates and DWSRF ineligibilities for

 2000–2019) .........................................................................................................................................................................37

Figure 4-3: Capital Payment Gap (Average No Revenue Growth Scenario) ...............................................................................39

Figure 4-4: Capital Payment Gap (Average Revenue Growth Scenario) ......................................................................................39

Figure 4-5: O&M Gap (Average No Revenue Growth Scenario) .................................................................................................41

Figure 4-6: O&M Gap (Average Revenue Growth Scenario) ........................................................................................................41

Table 2–1: Useful Life Matrix ..............................................................................................................................................................11

Table 3–1: Summary of 1996 Clean Water Needs Survey..............................................................................................................20

Table 3–2: Investment Needs, Costs, and Payments 2000–2019 (Billions of Dollars) .............................................................26

Table 4–1: Reported Drinking Water Infrastructure Needs (Billions of 1999 Dollars) ............................................................30

Table 4–2: Adjustment of Needs (Billions of 1999 Dollars).........................................................................................................31
Executive Summary

To gain a better understanding of the future

challenges facing the clean water and drinking water

industries, the U.S. Environmental Protection Agency

(EPA) has conducted a study to identify whether

there is a quantifiable gap between projected clean

water and drinking water investment needs over the

twenty-year period from 2000 to 2019 and current

levels of spending. The analysis found that a

significant funding gap could develop if the nation’s

clean water and drinking water systems maintain

current spending and operations practices.

However, this gap largely disappears if

municipalities increase clean water and drinking water

spending at a real rate of growth of three percent

per year. This real rate of growth represents a three

percent per year increase over and above the rate of

inflation and is consistent with the long-term growth

estimates of the economy.

The scope of this report is limited to a

discussion of methods for calculating the capital and

operations and maintenance (O&M) gaps for clean

water and drinking water. Although the findings will

inform policy discussion, this report confines itself

to estimating the gap, and it does not attempt to

discuss the array of policy considerations stemming

from the results.

In calculating capital investment needs over the

twenty-year period, both the clean water analysis and

the drinking water analysis used their respective

Needs Surveys as a starting point. Adjustments were

made to account for under-reporting of needs,

especially with regard to needs associated with capital

replacement. Estimates of capital needs for clean

water from 2000 to 2019 range from $331 billion to

$450 billion with a point estimate of $388 billion.

Estimates of capital needs for drinking water over

the twenty-year period range from $154 billion to

$446 billion with a point estimate of $274 billion.

The methods used several alternative

assumptions that generated hundreds of different

permutations for estimating the capital and O&M

gaps. The range represents the uppermost and

lowermost extremes of these estimates. Providing a

range explicitly acknowledges the uncertainty of the

analysis, which stems from the limited quality of the

available data and the potential for variance in key

factors affecting costs. The point estimates were

calculated by taking an average of each possible

combination of assumptions.

The analysis also compared projected

operations and maintenance (O&M) needs to

current spending. O&M needs for both clean water

and drinking water were assumed to be a function of

capital stock. To estimate current O&M spending,

both analyses used historical O&M spending data

from the Congressional Budget Office and the

Census Bureau and held this level constant over the

20-year period.

The resulting O&M gap for clean water over

the next twenty years is between $72 billion and $229

billion with a point estimate of $148 billion for the

no revenue growth scenario, and the gap is between

$0 billion and $80 billion with a point estimate of

$10 billion1

 for the revenue growth scenario. The

drinking water O&M gap is between $0 billion and

$495 billion with a point estimate of $161 billion2

 for

the no revenue growth scenario, and this gap is

between $0 billion and $276 billion with a point

Executive Summary

1 The actual range is $-55 to $80 billion with a point estimate

of $10 billion. Under the assumptions used for certain

scenarios, the models predict a surplus of infrastructure funds,

or rather, a negative gap. In these scenarios, total spending

and/or revenues will exceed the total need over the next 20

years. The report excludes these negative values in the text,

because systems generally would not collect revenues in excess

of their current estimated infrastructure needs. However, it

should be noted that doing so would free infrastructure funds

for situations where gaps remain.

2 The actual range is $-67 to $495 billion with a point estimate

of $161 billion. See Footnote 1 for further explanation.
estimate of $0 billion3

 for the revenue growth

scenario.

Whereas municipalities pay O&M costs from

current revenues, they often use debt instruments to

finance some of their clean water and drinking water

infrastructure investments. However, the portion of

clean water infrastructure that is financed is

significantly greater than the portion of drinking

water infrastructure that is financed. The analysis

assumes that clean water and drinking water systems

will finance a significant portion of projected capital

needs over the estimation period. Estimates of

payments for clean water capital needs range from

$321 billion to $454 billion, while estimates of

payments for drinking water capital needs range from

$178 billion to $475 billion.

Capital spending (payments) estimates for the

twenty-year period were made using historical data

from the Congressional Budget Office and the U.S.

Census Bureau. Current capital spending for clean

water is estimated at $13 billion per year. For

drinking water, current capital spending is estimated

at $10.4 billion per year.

The capital payments gap is equal to the capital

payment needs less the current spending on capital.

For clean water, estimates of the capital gap range

from $73 billion to $177 billion with a point estimate

of $122 billion for the no revenue growth scenario,

and the estimates range from $0 billion to $94 billion

with a point estimate of $21 billion4

 for the revenue

growth scenario. For drinking water, estimates of the

capital gap range from $0 billion to $267 billion with a

point estimate of $102 billion5

 for the no revenue

growth scenario, and the estimates range from $0

billion to $205 billion with a point estimate of $45

billion6 for the revenue growth scenario.

It is also important to note that the range of

needs and gaps are provided to explicitly acknowledge

variations within the estimates, but are not intended

to support comparative analysis between the clean

water and drinking water industries. The drinking

water analysis was able to use data sets that were not

available to clean water, e.g., data sets of pipe

inventory and age of assets. These data allowed

drinking water to use four different methods to

estimate capital needs and vary assumptions within

each method, whereas the clean water analysis used a

single method and varied assumptions within that

method. The broader array of methods available to

the drinking water analysis generated a broader range

of needs and gaps. As such, the resulting ranges

provide insight into the impact of varying

assumptions within each industry, but the data and

methods cannot be used to conduct a valid

comparison of the funding gaps facing the clean

water and drinking water industries.

EPA submitted the methods and data used in

this analysis to a panel of peer reviewers drawn from

academia, think tanks, consulting firms, and industry.

In general, the reviewers found that the analysis

represented a commendable and credible effort to

quantify the infrastructure gap. EPA refined the

analysis to address comments made by the reviewers,

although implementation of some of the

recommendations would require data that are as yet

unavailable. The results, therefore, should be viewed

with the understanding that the present body of data

constrains our ability to estimate the gap with a high

degree of certainty. This caveat aside, the report

offers estimates to ensure that policy discussions of a

pressing infrastructure challenge will not be

forestalled while we await improvements in data

quality—rather, any refinements to the estimates

should inform ongoing deliberations. The major

issues and concerns raised by the peer review panel

are summarized in Appendix B.

Executive Summary

3 The actual range is $-286 to $276 billion with a point estimate

of $-58 billion. See Footnote 1 for further explanation.

4 The actual range is $-39 to $94 billion with a point estimate

of $21 billion. See Footnote 1 for further explanation.

5 The actual range is $-17 to $267 billion with a point estimate

of $102 billion. See Footnote 1 for further explanation.

6 The actual range is $-94 to $205 billion with a point estimate

of $45 billion. See Footnote 1 for further explanation.
Introduction

Introduction

1.0 Purpose

The objective of this report is to determine

whether a potential funding gap could emerge

between projected needs and current spending with

respect to clean water and drinking water

infrastructure. The analysis presents in detail the

methods for quantifying the gap for the purpose of

providing transparency as to how the estimates were

derived. The results are expressed as a range; each

range also has a point estimate that is the average of

the different combinations of assumptions that could

be used in calculating the gap. By presenting the

findings as a range, the report acknowledges the

uncertainty. The report confines itself to quantifying

the funding shortfall for capital and operations and

maintenance (O&M) investments that will be needed

to ensure that clean water and drinking water systems

can continue to protect the environment and public

health. The policy implications of the funding gap

are beyond the scope of the present analysis. The

remainder of this chapter provides the historical and

technical context for understanding the infrastructure

issues confronting the clean water and drinking water

industries.

1.1 Background

Water is life. Clean and safe water is critical for

human health and ecosystem health. As early as 5000

years ago, centralized systems supplied drinking water

to communities in parts of the Middle East. Twentyfive hundred years ago, Athens, Greece rebuilt its city

with sewers that transported sanitary waste to rural

areas for disposal onto orchards and agricultural

fields. In the centuries since, these two services—

supply of drinking water and disposal of

wastewater—have become intrinsic responsibilities of

communities worldwide.

As recently as the mid-nineteenth century,

however, drinking water supply and wastewater

7

disposal were largely matters of transportation—of

bringing drinking water to citizens and removing

wastewater. In the United States, health concerns

and technological advances brought changes to

drinking water infrastructure around the turn of the

twentieth century. In 1872, Poughkeepsie, NY

introduced slow sand filtration to reduce turbidity in

drinking water. This treatment via filtration removed

microbial contaminants that had caused typhoid,

dysentery, and cholera epidemics. In 1908, Jersey

City, NJ introduced drinking water disinfection

treatment, and chlorination further reduced drinking

water disease outbreaks.

If a community’s wastewater received any

treatment prior to 1900, this treatment consisted of

physically separating solids and floating debris from

wastewater before discharge into a nearby waterbody.

In 1907, Gloversville, NY built the nation’s first

wastewater filtration facility, and in 1916, Chicago, IL

constructed an activated sludge treatment plant.

These advances, called secondary treatment, helped

to alleviate epidemics of typhoid, cholera, and other

waterborne diseases. This treatment also improved

ecosystem health—highlighted by resurging fish and

shellfish populations.

In the last century, treatment of drinking water

and wastewater has become more advanced, and it

has spread to almost all systems in the country. The

1972 Clean Water Act mandated that all publicly

owned treatment works (POTWs) provide secondary

treatment of wastewater. By 1996, fewer than 200

systems—out of 16,204 nationwide—had not met

this standard. The 1974 Safe Drinking Water Act

established a system of nationwide standards for

drinking water contamination. Today, the

Environmental Protection Agency regulates more

than 80 drinking water contaminants and the vast

majority of people receive drinking water from

systems that have no reported violations of healthbased standards.
8

















					

						

	

	

			

Figure 1–1: Increase in U.S. Population by Decade

Introduction

The advancement and expansion of clean water

and drinking water systems has been worthwhile but

costly. In the last twenty years, communities have

spent $1 trillion in 2001 dollars on drinking water

treatment and supply and wastewater treatment and

disposal.7 This spending is impressive, but it may not

be sufficient to keep pace with infrastructure needs

of the future. Several issues provide cause for

concern.

• Our systems are aging. Generally, installation of

clean water and drinking water infrastructure has

followed overall patterns of population growth

in cities across the country (Figure 1–1).

Treatment plants typically have an expected

useful life of 20–50 years before they require

expansion or rehabilitation. Pipes have life

cycles that can range from 15 to well over 100

years—with actual pipe life varying considerably

depending on soil conditions, pipe material,

climate, and capacity requirements. In some

eastern cities, systems have some pipes in use

that are almost 200 years old.

• Populations are increasing and shifting geographically.

The 2000 Census identified a population of 281

million in the country, an increase of more than

32 million from the 1990 Census. This change

was the largest census to census increase in

United States history. The Census Bureau

projects a population of more than 325 million

by the year 2020. Systems will need to increase

capacity to meet the demands posed by this

growth. To complicate the issue, population is

shifting geographically, requiring rapid increases

in system capacity in some parts of the country

and requiring maintenance of aging systems in

other parts of the country with diminishing

populations (and a diminishing rate base).

• Current treatment may not be sufficient. In 1998,

states, tribes, and interstate commissions

assessed water quality in 32 percent of the

nation’s estuaries and found 44 percent of the

assessed areas to be impaired. Wastewater

treatment facilities and combined (wastewater

and stormwater) sewer overflows were two of

the leading causes of impairment. Wastewater

treatment efficiencies may be leveling off, which,

when combined with population and economic

growth, could have the effect of reversing hardwon water quality gains. By 2016 pollution levels

could be similar to levels observed in the mid1970s (Figure 1–2).

• Investment in research and development has declined.

Innovation, research, and development are

essential elements in promoting the use of more

effective, efficient, and affordable technologies

in water and wastewater treatment. A recent

EPA report on R&D expenditures (public and

private) associated with water pollution

abatement showed that expenditures decreased

by half from the early 1970s to the late 1990s

(Figure 1–3).

7 Based on annual outlays reported in the Bureau of the

Census Government Finances Data Series for local

government expenditure for sewerage and the Engineering

News-Record’s Construction Cost Index (www.enr.com/cost/

costcci.asp).
9


















     

	

Figure 1–2: Projection of Increase in Biological Chemical

Oxygen Demand (BOD)8

			



		
 
		


 
     
     
 

















Figure 1–3: Declining Trend in R&D Water Pollution

Abatement Expenditures9

Introduction

• Services are non-centralized. Twenty-five percent

of all households in the U.S. have on-site

wastewater treatment systems and 15 percent of

all households receive drinking water from

private wells. Generally, states and communities

have not established adequate management

programs to assure proper functioning of onsite

systems for wastewater treatment and private

drinking water wells. This under-investment in

support results in poor location and design

decisions, inferior materials, faulty installation,

and a general lack of maintenance. Adequate

investment is critical to ensuring that these

systems operate properly. At the local, state,

and national level, more attention will have to be

paid in the future, not only to replace and repair

existing infrastructure, but also to establish and

support management programs.

• Some communities will have a difficult time meeting

funding challenges. Some communities, particularly

small communities which lack the economies of

scale associated with a large customer base, are

challenged in meeting the cost of installing and

maintaining infrastructure. The financial impact

of the need to address aging infrastructure will

be greater for these communities. There are

also communities in the country that are

unserved or underserved by clean water and

drinking water systems (Indian Tribes, Colonias,

Alaska Native Villages).

To gain a better understanding of the

challenges the clean water and drinking water

industries will face in the future, EPA has conducted

a study to identify whether there is a quantifiable gap

between the estimated investment needs for clean

water and drinking water systems and current

spending by these systems over the next 20 years. In

order to frame the discussion, Chapter 2 of this

report describes the characteristics of the clean

water and drinking water industries. Chapters 3 and

4 lay out the Agency’s identification of the needs and

spending associated with clean water and drinking

water infrastructure, respectively, in an effort to

identify whether there is a gap. Chapter 5

summarizes the findings and suggests areas for

further research.

8 U.S. EPA, Progress in Water Quality: An Evaluation of the

National Investment in Municipal Wastewater Treatment, June 2000.

9 U.S. EPA, A Retrospective Assessment of the Costs of the Clean

Water Act: 1972 to 1997, October 2000.
10


 

 
	




	





	






























 	



Figure 2–1: Percentage of Drinking Water Systems and

Population Served by Size Class

Characteristics of the Clean Water and Drinking Water Industries

Characteristics of the Clean Water and Drinking

Water Industries

2.0 Purpose

A discussion of the characteristics of the clean

water and drinking water industries provides a useful

context for understanding the results of the gap

analysis. For example, the differences between the

industries necessitated the use of different methods

in estimating needs, costs, and payments gaps.

2.1 Characteristics of the Clean Water

Industry

In the United States, there are 16,024 publicly

owned treatment works for treating municipal

wastewater. Although there are also some privately

owned wastewater treatment works, most of the

industry (98 percent) is in fact municipally owned.

These POTWs provide service to 190 million people,

representing 73 percent of the total population (at

the time of the 1996 Clean Water Needs Survey

Report to Congress). Seventy-one percent of the

facilities serve populations of less than 10,000 people.

Furthermore, approximately 25 percent of

households in the nation are not connected to

centralized treatment, instead using on-site systems

(e.g., septic tanks). Although many of these systems

are aging or improperly functioning, this analysis is

restricted to centralized collection and treatment

systems.

2.2 Characteristics of the Drinking Water

Industry

The drinking water industry has over ten times

the number of systems as the clean water industry.

Of the almost 170,000 public water systems, 54,000

systems are community water systems, that

collectively serve more than 264 million people. A

community water system serves more than 25 people

a day all year round. The remaining 114,000 water

systems are transient noncommunity water systems

(e.g., camp grounds) or non-transient noncommunity

water systems (e.g., schools). The scope of the gap

analysis is largely confined to community water

systems,10 as these systems serve most of the

population. Small systems serving fewer than 10,000

people comprise 93 percent of all community water

systems in the nation. However, most of the

population (81 percent) receives drinking water from

larger systems (Figure 2–1).

In contrast to the clean water industry, only

about 43 percent of community water systems are

publicly owned. Most of these systems are under the

authority of local governments (Figure 2–2).

Ownership type varies by system size—with almost

90 percent of systems serving more than 10,000

people under public ownership.

10 The Needs Survey data also includes $3.1 billion in needs

for 21,400 not-for-profit noncommunity systems. Therefore

this analysis includes those systems as well. It also includes

needs for Alaskan Native Villages and American Indian

systems.
11

	



 









 

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Figure 2–2: Percentage of Drinking Water Systems by Type

of Ownership

* Ancillary: Water

supply is not primary

purpose of business (e.g.,

mobile home park)

Characteristics of the Clean Water and Drinking Water Industries

2.3 General Characteristics of Capital

Stock and Impact on Operations and

Maintenance

The different components of capital stock that

make up our nation’s clean water and drinking water

systems vary in complexity, materials, and the degree

to which they are subjected to wear and tear. The

expenditures that utilities must make to address the

maintenance of systems are largely driven by the

condition and age of the components of

infrastructure.

2.3.1 Useful Life

The life of an asset can be estimated based on

the material, but many other factors related to

environment and maintenance can affect the useful

life of a component of infrastructure. On a national

level, it is not feasible to conduct a condition

assessment of all clean water and drinking water

infrastructure systems. However, approximation

tools can be used to estimate the useful life of these

infrastructure systems.

One such approximation tool is a useful life

matrix, which can serve as a tool for developing initial

cost estimates and for long-range planning and

evaluating programmatic scenarios. An example of a

matrix developed as an industry guide in Australia is

shown in Table 2–1.11 Although the useful life of a

component will vary according to the materials,

environment, and maintenance, matrices such as that

shown in Table 2–1 can be used at the local level as a

starting point for repair and replacement, strategic

planning, and cost projections. The U.S. as well as

other industrialized countries have engineering and

design manuals that instruct professional designers as

to the accepted standards of practice for design life

considerations. The U.S. Army Corps of Engineers,

the American Society for Testing Materials, the

Water Environment Federation, the American

Society of Civil Engineers, and several associations

maintain data that provides guidance on design and

construction of conduits, culverts, and pipes and

related design procedures.

The useful life of pipe, which comprises most

of the assets of both clean water and drinking water

systems, varies considerably based on a number of

factors. Some of these factors include the material

of which the pipe is made, the conditions of the soil

in which it is buried, and the character of the water

or wastewater flowing through it. In addition, pipes

11 The International Infrastructure Management Manual, Version

1.0. Australia / New Zealand Edition, April 2000
12

Figure 2–3: Example of Life Cycle Deterioration Curve 	

	


		

	

		














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Figure 2–4: Operations and Maintenance Spending from

State and Local Sources (1978–1994) '	
(
















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Characteristics of the Clean Water and Drinking Water Industries

do not deteriorate at a constant rate. During the

initial period following installation, the deterioration

rate is likely to be slow, and repair and upkeep

expenses low. For pipe, this initial period may last

several decades. Later in the life cycle, pipe will

deteriorate more rapidly. Figure 2–3 is an example of

a deterioration classification scheme.

The best way to determine remaining useful life

of a system is to conduct periodic condition

assessments. The new financial reporting

requirements (GASB 34) of the Government

Accounting Standards Board recognize the role

condition assessments play in advancing its

‘preservation report’ framework. At the local level,

service providers can conduct condition assessments

of their collection systems to ascertain their

condition for maintenance and replacement

purposes. It is essential for local service providers to

complete periodic condition assessments in order to

make the best life-cycle decisions regarding

maintenance and replacement.

2.3.2 Operating and Maintaining Capital Stock

As shown in Figure 2–4, spending in constant

dollars on operations and maintenance (O&M) for

clean water and drinking water has grown

significantly since 1970. In 1994, for example, 63

percent of the total spending for clean water was for

O&M, and 70 percent of the total spending for

drinking water was for O&M.12

Likely explanations for the increase in clean

water and drinking water O&M costs include the

following:

• Expansion and improvement of services,

which translated into an increase in capital stock

and a related increase in operations and

maintenance costs.

• Aging infrastructure, which requires

increasing repairs and increasing maintenance

costs.

Also, increases in clean water operations and

maintenance have been driven, in large part, by a

large number of solids handling facilities coming online. The installation of these facilities has increased

O&M costs beginning in the mid-1980s.

Over the next 20 years, O&M expenses are

likely to increase in response to the aging of the

capital stock: that is, as infrastructure begins to

12 Congressional Budget Office, Trends in Public Infrastructure,

May 1999.
13

)	*

+

,-


.

/


+

01



+

2	
/

0*-	

+

001

034

+

Figure 2–5: 1996 Clean Water Needs by Category (adjusted

for the SSO study)–$225 Billion in 2001 Dollars

* SSO estimate includes

Needs Survey results for

Infiltration/Inflow correction

and Sewer Rehab/

Replacement

Characteristics of the Clean Water and Drinking Water Industries

deteriorate the costs of maintaining and operating

the equipment will increase. An American Water

Works Association (AWWA) study found that

projected expenditures for deteriorating

infrastructure would increase steadily over the next 30

years.13 The projected increase in O&M costs finds

support in the historical spending data, which

indicate an upward trend for O&M (Figure 2–4).

Increasing O&M needs will present a significant

challenge to the financial resources of clean water

and drinking water systems. As the nation’s water

infrastructure ages, systems should expect to spend

more on O&M. Some systems might even postpone

capital investments to meet the rising costs of

O&M—assuming that their total level of spending

remains constant. The majority of systems likely

would increase spending to ensure that both capital

and O&M needs are fulfilled, and thus total spending

would increase significantly. Many systems would

recognize that delaying new capital investments would

only increase expenditures on O&M, as old and

deteriorated infrastructure would need to be

maintained at increasingly higher costs.

2.4 Clean Water Capital Stock

The basic components of clean water

infrastructure are collection systems and treatment

works. Systems vary across the clean water industry

as a function of the demographic and topographic

characteristics of the service area, the unique

characteristics of the particular waste stream, and the

operating requirements dictated in the permit

conditions. The type of treatment is largely

controlled by discharge limitations and performance

specified through state or federal permits.

The Clean Water Needs Survey collects needs

documentation from publicly owned treatment

works. Although the results likely underestimate true

needs, particularly when considering replacement of

pipes (discussed further in Chapter 3), they can serve

as an example of the components of a system.

Figure 2–5 shows the percent of need associated

with the major needs categories in the 1996 Clean

Water Needs Survey, adjusted based on results of the

Agency’s recent cost analysis conducted to estimate

costs associated with correcting sanitary sewer

overflows (SSOs).

Pipe networks represent the primary

component of a clean water system. During the last

century, as population grew and spread out from

urban centers, the amount of pipe increased as

homes were connected to centralized treatment.

Although there is not an actual inventory of the total

amount of sewer pipe associated with wastewater

collection systems in the U.S., the American Society

of Civil Engineers (ASCE)14 has developed an

estimate based on feet of sewer per capita—with the

average length estimated at 21 feet of sewer per

capita. The range varied from 18 feet to 23 feet per

capita. The resulting estimate is about 600,000 miles

of publicly owned pipe.

13 American Water Works Association, Dawn of the Replacement

Era: Reinvesting in Drinking Water Infrastructure, May 2001.

14 American Society of Civil Engineers, Optimization of

Collection System Maintenance Frequencies and System Performance,

February 1999.
14

Figure 2–6: Histogram of Miles of Sanitary Sewer Pipe

Installed per Decade


























      

5


Figure 2-7: Average Age of Wastewater Pipe Network 
	
6	





























Characteristics of the Clean Water and Drinking Water Industries

Because there is no nationwide inventory of

wastewater collection systems, the actual age of sewer

pipe is not known. However, it is safe to say that

installation of pipe has followed demographic

increases in population and growth in metropolitan

areas associated with suburbanization. Figure 2-6

represents an estimate of the amount of sewer pipe

installed per decade, using population, urban density,

and public sewerage system data from the U.S. Census

Bureau.

The vast majority of the nation's pipe network

was installed after the Second World War, and the

first part of this wave of pipe installation is now

reaching the end of its useful life. For this reason,

even if the pipe system is extended to serve growth

and the country invests in the replacement of all pipe

as it comes to the end of its useful life, the average

age of pipe in the system will still increase until at

least 2050 (Figure 2-7.)

Although there will be differences based on pipe

material and condition, the need to replace pipe will

generally echo the original installation wave. Figure 2-

8 applies a deterioration curve to the pipe network as

it ages from 1980 to 2020. Based on the deterioration

projections over the next twenty years, if the pipe

system is extended to serve growth but there is no

renewal or replacement of the existing systems, the

amount of pipe classified as either "poor," "very

poor," or "life elapsed" will increase from 10 percent

of the total network to 44 percent of the total

network.

Many of the wastewater treatment plants in the

U.S. were completely renovated with major plant

expansion and upgrade work beginning in the 1970s,

responding to new treatment requirements of the

1972 Clean Water Act and financed to a great extent

by EPA's Construction Grants program. Although

plants have shorter useful lives than sewer pipe, plant

replacement needs are not projected to be a major

part of the renewal and replacement requirements

until after 2020. In the near term, 22 percent of the

needs identified in the 1996 Clean Water Needs

Survey were related to treatment.

Of course, some of the components in the

treatment plants (e.g., mechanical and electrical

components) will need to be replaced within the next

20 years, but relative to the collection systems, they

are much less significant. Furthermore, there tends

to be greater awareness of the condition of the plant

structures since they are easier to observe (i.e., not

buried underground) and are subject to more

frequent inspection. However, there are implications

to the costs associated with the plants. As the

treatment plants continue to age, their operation and

maintenance costs will increase at a more rapid rate,

having a major impact on future operating budgets.
15

	
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Figure 2–8: Shift in the Likely Condition Associated with the Aging Miles of Pipe in the Network

(percentage of pipe by classification)

Characteristics of the Clean Water and Drinking Water Industries

Furthermore, because so many treatment plants

were constructed near the same point in time (i.e.,

beginning in the 1970s), replacement needs will hit at

relatively the same time. The initial treatment plant

replacement needs will occur at the same time that

many pipes installed post-WWII will begin requiring

replacement. Deferral of timely renewal and

replacement associated with the oldest pipe over the

next twenty years will likely put a system in a difficult

financial condition. The typical system could

experience a very significant bump in expenditures

over a very short period of time to accommodate

replacement of old pipes, new pipes, and plant

structures in the same time frame.

2.5 Drinking Water Capital Stock

The analysis in Chapter 4 discusses the needs

and spending associated with maintaining the capital

stock of public drinking water systems. The capital

stock of an individual drinking water system can be

broken down into four principal components: source,

treatment, storage, and transmission and distribution

mains. Each of these components fulfills an

important function in delivering safe drinking water

to the public.

While there is no study available that directly

addresses the capital make-up of our nation’s

drinking water systems, a general picture can be

obtained from the 1999 EPA Drinking Water

Infrastructure Needs Survey (Figure 2–9). Although

it is the least visible component of a public water

system, the buried pipes of a transmission and

distribution network generally comprise most of a

system’s capital value. Transmission and distribution

needs accounted for 55 percent of the total need

reported in the 1999 survey. Treatment facilities

that are needed to address contaminants with acute

and chronic health effects represented the second

largest category—with 25 percent of the total need.

Storage projects needed to construct or rehabilitate

finished water storage tanks represented 12 percent

of the total need. Projects needed to address

sources of water accounted for six percent. The

source category included needs for constructing or

rehabilitating surface water intakes, raw water

pumping facilities, drilled wells, and spring collectors.

Neither the storage nor source categories considered

needs associated with the construction or

rehabilitation of raw water reservoirs or dams.

The need to replace aging transmission and

distribution components is a critical part of any

drinking water system’s capital improvement plan. A

recent AWWA report, Dawn of the Replacement Era,

15

surveyed the inventory of pipe and the year in which

15 American Water Works Association, Dawn of the Replacement

Era: Reinvesting in Drinking Water Infrastructure, May 2001.
16

12

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Figure 2–9: Percent Needs by Drinking Water Infrastructure

Category (total needs $150.9 billion) 	/

6	/
	

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Figure 2–10: Age Distribution of Current Inventory of Pipe for 20 Cities

Characteristics of the Clean Water and Drinking Water Industries

the pipe was installed for 20 cities in an effort to

predict when the replacement of the pipe would be

needed. While the 20 cities in the sample were not

selected at random, the cities likely represent a broad

range of systems of various ages and sizes from

across the country. More importantly, the study

provides the only available data on the age of pipe

from a reasonably large number of systems. Figure

2–10 shows the distribution of the age of pipe

currently in the inventory of these 20 cities.

While Figure 2–10 presents the distribution of

the age of pipe for the 20 cities, the data do not

indicate when the pipe would need to be replaced.

Age is one factor that affects the life expectancy of

pipe. A simple aging model, therefore, was

developed to predict when pipes for these 20 cities

would need to be replaced. It was assumed that pipes

installed before 1910 last an average of 120 years.

Pipe installed from 1911 to 1945 is assumed to last an

average of 100 years. Pipe installed after 1945 is

assumed to last an average of 75 years. In estimating

when the current inventory of pipe will be replaced,

the model assumes that the actual life span of the

pipe will be distributed normally around its expected

average life; that is, pipe expected to last 75 years will

last 50 to 100 years, pipe expected to last 100 years

will last from 66 to 133 years, and pipe expected to

last 120 years will last 80 to 160 years.

This assumption greatly simplifies reality, as the

deterioration rates of pipe will vary considerably as a

function not only of age, but also of climatic

conditions, pipe material, and soil properties. Pipe of

the same material, for example, can last from 15

years to over 200 years depending on the soil

characteristics alone. In the absence of data that

would allow for the development of a model to

estimate pipe life (i.e., accounting for local variability

of pipe deterioration), the application of a normal

distribution to an average life expectancy may

provide a reasonable approximation of replacement
17

Figure 2–11: Projected Annual Replacement Needs for Transmission Lines and Distribution

Mains, 2000–2075

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Figure 2–12: Change in Distribution of User Fees for Communities in Ohio between 1989 and 1999

Characteristics of the Clean Water and Drinking Water Industries

rates. This model also does not account for other

factors, most notably inadequate capacity, that may

have equal or greater importance than deterioration

in determining pipe replacement rates.

Applying this simple aging model to the

historical inventory of pipe for the 20 cities reveals

that most of the projected replacement needs for

those cities will occur beyond the 20-year period of

the analysis–with peak annual replacement occurring

in 2040 (Figure 2–11). This conclusion makes sense

considering that most of the nation’s drinking water

lines were installed after the 1940s.

2.6 Costs of Providing Service

Although many water and wastewater providers

obtain funds from the federal government to finance

the costs of capital improvements, most of the

funds that systems use for both capital and

operations and maintenance come from revenues

derived from user fees. As utilities look to address
18

Figure 2–13: Percentage Point Change in Share of Aggregate

Income for Households (measured from initial year in range) 
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Characteristics of the Clean Water and Drinking Water Industries

future capital needs and increasing O&M costs, they

may need to increase fees to obtain the funding

needed for these activities.

While there is no complete source of national

data on how rates have changed through time, the

State of Ohio has information that can serve as an

example for the purposes of a simple discussion. For

more than 15 years, the State has conducted an

annual survey of water and sewer rates for

communities in the state. Data from communities

that reported rates for both 1989 and 1999 reveal that

there has been an upward shift in the number of

communities paying higher annual fees with time

(Figure 2–12).

User rates that are needed to meet the cost of

providing service have the potential to negatively

impact those segments of the population with low

incomes. Data from the Census Bureau16 show that

between 1980 and 1998, incomes at the lower range

(as a percentage share of aggregate income for

households) declined or stagnated (Figure 2–13). If

rates increase to fund increasing needs, utilities may

be challenged to develop rate structures that will

minimize impacts on the less affluent segments of

society.

16 U.S. Census Bureau, The Changing Shape of the Nation’s Income

Distribution, U.S. Census P60-204, Current Population Reports

Series, June 2000.
19

3.0 Purpose

The purpose of this analysis is to quantify the

relationship between the estimated infrastructure

needs of clean water systems over the next 20 years

and current levels of spending. The limitations of the

data necessitate reporting the results of the analysis

as a range. A range explicitly acknowledges the

uncertainty of the analysis, specifically, the different

underlying assumptions that can be used (with no

clear distinction of validity) to estimate the capital

and O&M needs. Within each range, however, the

analysis provides a point estimate, which represents

the average of the hundreds of different scenarios

that can be generated for each combination of

assumptions.

3.1 General Steps

The method for estimating the difference

between needs and current spending involves five

primary steps, each of which is described in the

following sections.

1. Estimate the total capital investment needs

for the next 20 years using data from the 1996

Clean Water Needs Survey, add a modeled

estimate of Sanitary Sewer Overflow needs, and

then adjust the analysis for underreported

replacement needs.

2. Calculate the impact of financing the capital

investment needs to determine the total capital

cost and the total capital payments from 2000–

2019.

3. Estimate the total O&M needs for the next

20 years using data from the Bureau of the

Census Government Finances Data Series for

local government expenditure for sewerage.

Methods for Estimating Needs and Spending for

Clean Water

Methods for Estimating Needs and Spending for Clean Water

4. Considering historical spending, develop

base levels of current annual capital spending

and current annual O&M spending. Historical

data on local government expenditures for

sewerage are taken from the Bureau of the

Census Government Finance Data Series.

5. Compare the projected annual needs to

current annual spending estimates, considering

both capital needs and O&M needs, and project

the annual payment gap in clean water

spending.

3.2 The Clean Water Capital Need

3.2.1 Clean Water Capital Investment Needs

The 1996 Clean Water Needs Survey (CWNS)

provides data to estimate the total capital investment

need over 20 years. The CWNS identifies a total

capital investment need of $156.9 billion.17 Table 3–

1 summarizes the results of the needs survey.

A few factors may lead the CWNS to

underreport needs at wastewater facilities over the

next twenty years.18 First, the CWNS mainly

identifies capital investment needs related to

compliance, not needs related to service levels.

Second, the CWNS includes only needs that can be

justified by project-specific documentation that

describes the nature of the problem, recommended

solutions, and the basis of the cost estimate. Survey

information is collected through a buildup of state

and local estimates, which are subjected to quality

control review techniques to assure consistent

17 All figures in Chapter 3 are adjusted to 2001 dollars using

the Engineering News-Record’s Construction Cost Index

(www.enr.com/cost/costcci.asp).

18 An updated needs survey, the 2000 Clean Water Needs

Survey, will be submitted to Congress in August 2002.
20

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Table 3–1: Summary of 1996 Clean Water Needs Survey

Methods for Estimating Needs and Spending for Clean Water

treatment of data. The documentation requirement

provides assurance that the needs and costs derived

from different sources can be aggregated since they

are developed using similar criteria and applying a

common standard. Where little documentation exists

across a need category, such as costs for controlling

combined sewer overflows, sanitary sewer overflows,

and storm water, EPA develops estimates using cost

models.

Third, the need is only defined as a need if it

exists on January 1 of the needs survey year (e.g., 1/

1/96 for the 1996 survey). In other words, to have a

future need recognized, it must be tied to a current

need. The fourth factor is the planning period used to

estimate needs. Historically, clean water infrastructure

needs were planned and implemented based on a 20-

year planning period. More recently, communities

have been using a shorter planning period (e.g., 5 to

10 years), so the estimates they report for the Clean

Water Needs Survey likely do not include the full cost

needs associated with the 20-year period. This

analysis assumes that modeling Sanitary Sewer

Overflow needs and developing an underreported

replacement estimate will capture many, if not most,

of the underreported needs relating to existing

infrastructure.

The clean water capital investment need is

estimated in the following manner.

1. The CWNS identifies a total capital

investment need of $156.9 billion for 20 years.

2. CWNS-identified needs for activities related

to nonpoint source (e.g., agriculture, silviculture,

urban runoff, estuaries, wetlands, and

groundwater) (Category VII—$12.9 billion) are

eliminated from the analysis.

3. The CWNS also identifies infrastructure

needs for infiltration/inflow correction and

sewer replacement/rehabilitation (Category III).

These needs ($11.6 billion) are replaced in this

analysis by modeled estimates ($92.1 billion)

developed by EPA to better estimate the costs

associated with correcting existing SSO

problems in existing wastewater collection

systems and bringing them into compliance with

existing regulations. EPA based the SSO needs

estimate on data from the 1996 Clean Water

Needs Survey database and case studies from 65

municipalities. The methodology to estimate

capital costs associated with reducing SSOs

included a hydrologic model. The model

simulates the effects of wet weather on each

separate sanitary sewer system; a set of cost

functions associated with infiltration/inflow

reduction, storage, and treatment; and an

optimization routine to determine the least

costly combination of infiltration/inflow

reduction, increased storage, and increased

treatment.

4. This analysis then adjusts for underreported

replacement needs. The development of this

underreported replacement needs estimate is

somewhat complex. This analysis assumes that
21

Methods for Estimating Needs and Spending for Clean Water

capital stock (wastewater treatment facilities,

sewer systems, and rolling stock) has an average

depreciation period of 60 years, an assumption

developed by the Bureau of Economic Analysis.

To model this assumption, this analysis assumes

a replacement need of 3.3 percent (1/30) of net

capital stock on an annual basis (roughly equal

to 1.6 percent (1/60) of the non-depreciated

capital stock constructed in the 60-year

depreciation period). To simulate the turnover

in capital stock over different periods of time,

this analysis also developed scenarios in which

net capital stock is replaced at annual rates of 4

percent and 2.9 percent, which translate roughly

into a turnover of capital stock in 50 years and

70 years, respectively. The additional scenarios

show how aggregate estimates are affected if the

capital stock turns over at different rates.

Before this underreported replacement

needs estimate is completed, however, it is

reduced to account for replacement needs that

are reported in the CWNS and modeled in the

SSO estimate. Alternative scenarios used in this

analysis assume that 1⁄4, 1⁄2, or 3⁄4 of the SSO

estimate reflects replacement costs.

Data on the net capital stock from 1972–

1990 are derived from the Consolidated

Performance Report, a report that incorporates

data from the Bureau of the Census

Government Finances Data Series.19 The

analysis uses an iterative process to derive net

capital stock values for each year by adding new

stock and depreciation to the previous year’s net

capital stock value.20

Equation for each year’s Underreported

Replacement Needs Estimate

R = D*K - S*A/T

Where:

R = replacement need

D = depreciation rate for net capital

stock

K = net capital stock

S = replacement costs in SSO

estimate

A = annual reported capital

investment needs

T = reported capital investment

needs for 2000–2019

*****

In this analysis, the 20-year clean water capital

investment need estimate ranges from $331 billion to

$450 billion.

3.2.2 Capital Financing Costs And Payments

While some systems may purchase

infrastructure with current revenues, many use debt

financing for at least a portion of their infrastructure

investments. According to the Bureau of Economic

Analysis, clean water systems have historically used

debt to finance 90 percent of their capital stock with

municipal bonds or government loans. In this

analysis, alternative scenarios assume that 75 percent,

85 percent, or 95 percent of capital investments will

be financed.

This analysis distinguishes between capital

investment needs (discussed in section 3.2.1), capital

costs (including financing costs), and expected

payments for capital investments (a measurement of

cash flow needs). Although considerations of

payment needs are most important for this

infrastructure challenge, each estimate has value in

policy discussions. However, investments must be

19 Corps of Engineers, Consolidated Performance Report on the

Nation’s Public Works: An Update (IWR Report 94-FIS-13,

December 1994).

20 Equation for Net Capital Stock

Kt

 = Kt-1 + It - D*Kt-1

Where: Kt = net capital stock in year t,

It = capital investment (i.e., need) in year t, and

D = annual depreciation of net capital stock

(expressed as a fraction)
22



  	



	












































Figure 3–1: Projected Capital Costs (Average Scenario)

Methods for Estimating Needs and Spending for Clean Water

compared with investments, costs with costs, and

payments with payments.

To estimate payments for capital investments

and the resulting financing costs, the model makes

the following assumptions:

1. Systems use municipal bonds or government

loans to finance 75 percent, 85 percent, or 95

percent of their capital investments.

2. Systems borrow at a real interest rate of 2.5,

3.0, or 3.5 percent.

3. Loans have a term of 20, 25, or 30 years.

4. Systems will make level debt service payments

over the life of the loan. The payment is given

by:

where:

p = the amount of the annual

payment;

k = the value of the infrastructure

purchased;

r = the real interest rate; and

n = the duration of the loan.

5. Each annual investment is simulated as a

separate bond.

6. Debt service for old debt instruments does

not include investments paid with EPA grants.

7. The amount not financed (for example, 15

percent of the total each year) is paid for in the

year in which the infrastructure is purchased.

With these varied assumptions, if associated

financing costs are accounted towards the year in

which an investment is made, the capital financing

cost ranges from 21.4 percent to 60.0 percent.21 As a

result, the capital cost estimate (including financing

costs) ranges from $402 billion to $719 billion (Figure

3–1).

The term “payment” is used to indicate cash

flows, e.g., when debt service payments for the

investments are actually paid. Since a portion of the

total need is purchased each year over the 2000–2019

period, and since a portion of each year’s purchase is

financed over a 20-year period, all interest and

principal payments are not paid for in full by 2019.

However, an estimate of payments for capital

investments must also include payments related to

existing debt (Figure 3–2). The estimate of payments

for capital investments in this twenty-year period

ranges from $321 billion to $454 billion. These

payments service existing debt, service debt incurred

from 2000–2019, and cover pay-as-you-go

expenditures. The total estimate of payments needed

for capital investments is compared to current

spending levels in section 3.6 to estimate clean water’s

capital gap. It is important to note that these

21 For example, if annual capital financing needs are $100, and

75 percent of these needs are financed at a real interest rate of 3

percent over twenty years, an amortization schedule with level

debt service will result in total payments of $100.82. The cost

of borrowing ($100.82 - $75.00 = $25.82) is 25.8 percent of the

annual capital financing needs. This ratio holds for any volume

of annual capital financing needs.
23

Figure 3–2: Projected Capital Payments (Average Scenario)







































	









 

!"
 

Figure 3–3: Annual Operations and Maintenance Cost Measured as a Percentage of

Net Capital Stock (Average Scenario)

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Methods for Estimating Needs and Spending for Clean Water

estimates assume that the local governments fund the

entire increase in projected capital costs. Should state

or federal sources provide local governments with

grants or low-cost loan assistance, the total projected

local payments would decrease because less capital

would need to be financed.

3.3 Estimate Total O&M Needs

This analysis estimates future O&M needs by

considering the ratio of O&M expenditures to net

capital stock. According to O&M outlay data derived

from the Bureau of the Census Government

Finances Data Series for local government

expenditure for sewerage, this ratio grew in linear

fashion from 1972-1996. O&M needs grew from 3.7

percent of net capital stock in 1972 to 7.4 percent of

net capital stock in 1996. This linear trend might be

expected to continue if O&M costs were to continue

to largely reflect service and treatment costs—and

net capital stock were to continue to grow due to

increasing service and treatment. However, this

model assumes that O&M costs related to the

maintenance of aging systems will increase, and it

assumes that capital stock increases will increasingly

reflect a different kind of expenditure—the eventual

replacement of aging infrastructure.

By itself, an aging infrastructure should result in

increasing O&M expenditures because of the

increased need for repairs. However, a model that

estimates O&M as a fixed percentage of net capital

stock would project declining O&M as the net value

of an aging capital stock declines, exactly the

opposite of what should happen. Assuming an

increasing ratio of O&M to net capital stock, which
24

Figure 3–4: Projected O&M Payments (Average Scenario) 










































Figure 3–5: Capital Payment Gap (Average No Revenue

Growth Scenario) 










































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Methods for Estimating Needs and Spending for Clean Water

is consistent with recent data, can overcome this

problem.

Conversely, a major pipe replacement campaign,

as contemplated in the capital needs assessment,

should moderate the growth in O&M expenditures

because old leaky pipes are being replaced by new

lower maintenance pipes. In this case, however, a

model that estimates O&M as a fixed percentage of

net capital stock would project increasing O&M

because the projection is driven by the major

increases in net capital stock from the pipe

replacement program. Again, this is exactly the

opposite of what should happen. Under this

scenario, a decreasing ratio of O&M to net capital

stock is arguably most appropriate.

However, given the uncertainty about what will

actually happen in practice to the ratio of O&M to

net capital stock, the base case of this analysis

assumes that the ratio of O&M to net capital stock is

frozen at the level from the last actual data on O&M

and net capital stock (Figure 3-3). The upper bound

case assumes a linear increase over the 20-year period

to a level in 2019 that is one percent above the base

case O&M to net capital stock ratio, while the lower

bound case assumes a one percent decline in the ratio

over the 20-year period.

In this analysis, the O&M needs estimate for

2000-2019 ranges from $406 billion to $562 billion

(Figure 3-4). This analysis assumes that clean water

systems will not finance any O&M costs. The

estimate of payments needed for O&M is compared

to current spending levels and to a baseline of

revenue growth in section 3.6 to estimate clean

water's O&M gap.
25

Figure 3–7: O&M Gap (Average No Revenue Growth

Scenario) 










































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Figure 3–8: O&M Gap (Average Revenue Growth

Scenario)

Methods for Estimating Needs and Spending for Clean Water

3.4 Estimate Current Spending

In order to calculate the gap, the projected

payments for capital investments and O&M are

compared to current levels of spending.

3.4.1 Payments for capital investments

In 2001 dollars, historical payments for capital

investments from local government have been

relatively flat. This analysis uses an estimate of FY

1996 capital payments ($13.0 billion) to establish a

current level of spending. This figure is based on (a)

data for local government capital investments from

1973–1996 derived from the Bureau of the Census

Government Finance Data Series for local

government expenditures, (b) estimates of federal

grants based on annual appropriation bills and the

CRS report Water Infrastructure Financing: History of

EPA Appropriations 1986-1998, and (c) an assumption

that historical capital investment has been financed as

described in section 3.2.2.

3.4.2 Payments for O&M needs

As discussed in section 3.5, O&M spending has

steadily increased over the past two decades. For this

reason, this analysis uses estimated FY 1996 O&M

spending ($16.7 billion) as the baseline for current

spending. Spending for O&M needs from 1973–

1996 is reported in the Bureau of the Census

Government Finance Data Series for local

government expenditures.

3.5 Estimate the Total Payment Gap

The annual capital payment gap is the

difference between the estimated payments and

projected spending in each year. The total payment

gap over the 20 years is the sum of the annual

payment gaps. In this analysis, the estimates of the

clean water capital payment gap range from 73

billion to 177 billion with a point estimate of $122

billion for the no revenue growth scenario (Figure 3-

5), and the estimates range from $0 billion to $94

billion with a point estimate of $21 billion22 for the

revenue growth scenario (Figure 3-6).

22 The actual range is $-39 to $94 billion with a point estimate

of $21 billion. Under the assumptions used for certain

scenarios, the models predict a surplus of infrastructure funds,

or rather, a negative gap. In these scenarios, total spending

and/or revenues will exceed the total need over the next 20

years. The report excludes these negative values in the text,

because systems generally would not collect revenues in excess

of their current estimated infrastructure needs. However, it

should be noted that doing so would free infrastructure funds

for situations where gaps remain.
26

	
	


	





	






	
		


	


		








	
	




	

	
	

	

		


 

	



	





		

	





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Table 3–2: Investment Needs, Costs, and Payments 2000–2019 (Billions of Dollars)

Methods for Estimating Needs and Spending for Clean Water

The estimates of the O&M payment gap range

from $72 billion to $229 billion with a point estimate

of $148 billion for the no revenue growth scenario

(Figure 3-7), and the estimates range from $0 billion

to $80 billion with a point estimate of $10 billion27

for the revenue growth scenario (Figure 3-8).

This analysis considered three possibilities for

six assumptions (e.g., real interest rates for municipal

borrowers of 2.5 percent, 3.0 percent, and 3.5

percent). The analysis considered all of these

possibilities to generate hundreds of permutations of

these payment gaps. A point estimate was obtained

23 The actual range is $-39 to $94 billion with a point estimate

of $21 billion. See Footnote 22 for further explanation.

24 The actual range is $-2 to $5 billion with a point estimate of

$1 billion. See Footnote 22 for further explanation.

25 The actual range is $-94 to $143 billion with a point

estimate of $31 billion. See Footnote 22 for further

explanation.

26 The actual range is $-5 to $7 billion with a point estimate of

$2 billion. See Footnote 22 for further explanation.

27 The actual range is $-55 to $80 billion with a point estimate

of $10 billion. See Footnote 22 for further explanation.
27

Figure 3–9: Cumulative Growth in Sewerage Expenditures and Gross Domestic Product 1980-1999 3*3	$-2	

















    
   

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Methods for Estimating Needs and Spending for Clean Water

by simply taking an average of all of the scenarios.

This report characterizes a “Gap” in the

context of asset management practices. The annual

capital payment gap and annual O&M payment gap

identified above best represent this “Gap.” Other

reports have considered the “Gap” using a capital

cost gap.

Each of these different estimates is represented

in Table 3–2. Although the infrastructure challenge

is best evaluated by considering the flow of

payments, i.e., when and how much systems invest

(in the table, row 4), the gap can also be evaluated by

considering total capital needs (1), total capital costs

(2), and O&M costs (3).

3.6 No Revenue Growth and Revenue

Growth Scenarios

The no revenue growth and revenue growth

scenarios in this analysis provide different

alternatives for viewing the potential gap in

spending. The no revenue growth scenario shows

how much additional funding would be required to

address projected needs without considering

potential growth in revenues. However, that

scenario does not consider how sewer revenues will

increase if the national economy grows.

The revenue growth scenario provides this

perspective, although it includes two types of

uncertainties. The first is whether or not the

economy grows, as projected, with a three percent

real annual growth rate in gross domestic product

(GDP). Although this growth rate is uncertain, it is

consistent with (actually slightly below) the growth

rate projections currently being used by both the

Office of Management and Budget and the

Congressional Budget Office. The second type of

uncertainty is whether or not municipal spending on

wastewater will actually keep track with the pace of

growth in GDP.

While the actual outcome will reflect municipal

policy decisions on the relative demands for various

types of local services, recent historical experience

(see Figure 3-9) has shown that overall sewer

expenditures have tracked fairly closely with growth

in GDP. Given that wastewater O&M costs have

been exclusively a local responsibility and that capital

conveyance system (pipe) projects have historically

been largely a local responsibility, it is not

unreasonable to assume that localities would make

significant wastewater needs a priority to maintain

their share of municipal revenue in a growing

economy. It should be understood that neither the

revenue growth scenarios nor the no revenue growth

scenarios imply that needs and revenues are

uniformly distributed across the country.
28

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the Gap Estimate

Methods for Estimating Needs and Spending for Clean Water

3.7 Key Variables

This analysis indirectly considers many factors

that impact expenditure estimates in a positive or

negative fashion. Figure 3–10 is a qualitative

assessment that describes some of these factors. By

far the most important factors listed are estimates of

repair costs and maintenance costs—estimates that

reflect assumptions about the current condition of

the nation’s wastewater infrastructure.
29

The limitations of the data necessitate reporting

the results of the analysis as a range. A range

explicitly acknowledges the uncertainty of

assumptions that can be used (with no clear

distinction of validity) to estimate the capital and

O&M needs. Within each range, however, the

analysis provides a point estimate that represents the

average of the hundreds of different scenarios that

can be generated for each combination of

assumptions.

4.1 General Steps–Capital Needs

The method for estimating the difference

between capital payment needs and capital spending

involves five primary steps, each of which is

described in the following sections.

1. Estimate the total capital investment need

for the next 20 years based on one of four

scenarios, each of which uses some portion of

data from the 1999 Drinking Water

Infrastructure Needs Survey.

2. Allocate the total capital investment need by

year.

3. Estimate capital cost and the capital payment

needs by calculating debt service financing for a

percentage of the capital investments.

4. Using data from the Congressional Budget

Office, estimate current capital spending.

5. Compare the annual capital payment needs

to annual capital spending. The difference is

the annual capital payment gap.

4.0 Purpose

The purpose of this analysis is to quantify the

relationship between the estimated infrastructure

needs of drinking water systems over the next 20

years and current levels of spending. In estimating

future capital needs, the analysis excludes capital

projects related to Drinking Water State Revolving

Fund (DWSRF) ineligible needs, such as dams and

future growth. The lack of a defensible means to

quantify these costs is the primary reason for their

exclusion. Although the following sections are

limited to DWSRF eligible capital needs and

spending, the potentially substantial costs associated

with ineligible needs, most notably, future growth,

should be borne in mind when considering the

broader financial challenge with which water systems

will need to contend. It is also important to note

that the analysis excludes needs associated with

regulations that EPA has not yet proposed.

The focus on capital needs and spending

mirrors the level of federal involvement in drinking

water infrastructure in terms of funding assistance.

The DWSRF provides loans and other forms of

financial assistance to water systems for capital

improvement projects, consolidation, acquisition of

existing infrastructure, and refinancing loans. The

DWSRF does not provide loans for O&M.

Nonetheless, water systems will face mounting costs

related to O&M as the capital stock ages and as new

infrastructure is added to the network. In recognition

that the costs associated with O&M allow for a more

complete picture of the challenges facing water

systems, the last section of the chapter provides an

analysis of the needs and spending associated with

O&M.

Methods for Estimating Needs and Spending for

Drinking Water

Methods for Estimating Needs and Spending for Drinking Water
30

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Table 4–1: Reported Drinking Water Infrastructure Needs (Billions of 1999 Dollars)

Methods for Estimating Needs and Spending for Drinking Water

4.2 The Drinking Water Capital

Investment Need

4.2.1 Treatment, Source and Storage Needs

(“non-pipe” needs)

The 1999 Drinking Water Infrastructure

Needs Survey (DWINS) provides data to

estimate the total capital need over the next 20

years. The total need is $150.9 billion in 1999

dollars. Table 4–1 summarizes the results of the

needs survey.

Several adjustments to the reported need

are necessary to capture more completely the

capital needs over the estimation period. The

estimation of annual non-pipe capital needs

involves 4 steps.

1. The DWINS identifies non-pipe needs of

$63.0 billion (for information about the annual

allocation of non-pipe needs from 2000–2019,

see section 4.3.)

2. The DWINS also identifies infrastructure

needs required to comply with recently

promulgated and proposed regulations: $9.3

billion. Because most systems had not yet

identified the infrastructure needed to comply

with these new regulations, the Needs Survey

used the Economic Analyses, which EPA

published when proposing or finalizing the

regulations, to estimate compliance costs. The

analysis assumes that water systems will need to

install the infrastructure to comply with these

regulations before the statutory compliance

dates of the rules, i.e., within the next 5 years.
31

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Table 4-2: Adjustment of Needs (Billions of 1999 Dollars)

Methods for Estimating Needs and Spending for Drinking Water

3. The analysis then adjusts the DWINS

estimates to account for under-reporting. The

methods used by the DWINS yield a

conservative estimate of need. EPA sent

questionnaires to a random sample of 2,556

medium sized systems serving between 3,300

and 40,000 people and to all 1,111 large systems

serving more than 40,000. In completing the

survey questionnaire, many of these systems

relied exclusively on planning documents, such

as Capital Improvement Plans (CIPs), that often

covered just one to five years, rather than the

20-year scope of the survey. Thus, these systems

likely overlooked eligible projects that will be

needed beyond the time frame of their planning

documents. In addition, planning documents

generally reflect the financial resources available

to the systems. Therefore, even though a system

may need to replace most of its deteriorated

distribution mains over the next 20 years, the

CIP may include a much smaller portion owing

to the projected availability of funding.

In 1997, EPA conducted 200 site visits to

medium and large water systems that had

responded to the first Needs Survey, which was

completed in 1995. The purpose of the followup study was to investigate the accuracy of the

responses. The study quantified the extent to

which medium and large systems underreported their needs in comparison to the

needs identified during the site visits. The

estimate of need for medium and large systems

is multiplied by 1.49 to account for underreporting. This adjustment was developed

directly from the follow-up study (i.e., systems

under-reported the needs associated with

treatment, storage, and source needs by a factor

of 1.49). The total non-pipe capital need (for

current and future needs of small, medium, and

large systems), as adjusted for under reporting,

is $84.4 billion. The adjustments are shown in

Table 4–2.

EPA conducted site visits to assess the needs of

small systems serving fewer than 3,300 people,

as these systems generally lack the specialized

personnel and planning documents required to

complete a questionnaire. Because professional

water system engineers conducted on-site

inspections of small systems, it is assumed that
32

Methods for Estimating Needs and Spending for Drinking Water

the estimate of the need for small systems

requires no adjustment for under-reporting.

4. The 1999 DWINS needs are reported in 1999

dollars. After adjusting the reported need for

inflation to 2001 dollars, the total non-pipe need

is $97.6 billion.

4.2.2 Transmission Lines and Distribution Mains

The analysis developed four options to estimate

transmission line and distribution main needs.

1. In the first option, pipe needs were obtained

from the 1999 Needs Survey. Transmission lines

and distribution mains account for most (55

percent) of the reported need.

The transmission and distribution needs are

multiplied by 1.605 to account for underreporting. This factor was derived from the 1997

follow-up study (i.e., systems under-reported

their transmission and distribution needs by a

factor of 1.605). The adjustment of the

transmission and distribution needs (for

underreporting and adjustment to 2001 dollars)

yields an estimate of $120 billion over the next

20 years. By comparison, AWWA uses a pipe

replacement model that produces a total need of

$250 billion, but over 30 years.28 Using AWWA’s

methods to determine the value of pipe

replacement over the next 20 years generates an

estimate of $52 billion (i.e., most of the need

falls beyond the next 20 years).

The advantage of using the Needs Survey is that

it reflects actual needs identified and

documented by water systems, as opposed to a

pipe replacement model which would substitute

these needs with a modeled estimate. Also, the

set of assumptions required to build a pipe

replacement model simplify reality without

necessarily contributing more worth to the

analysis. The disadvantage of this method is that

the estimates can only be apportioned into

current and future needs. Thus, the option will

not reflect the aging in capital stock that is

expected to occur over the next 20 years, and

instead distributes the total need according to a

specified time frame.

2. For option 2, the analysis substitutes the

transmission and distribution need from the

1999 Needs Survey estimate with an estimate

based on a pipe replacement model. The nonpipe needs estimated by the Needs Survey would

be adjusted for under-reporting and added to

the modeled pipe estimate to obtain the total

capital need. The non-pipe needs are distributed

according to current/future time frames or

spread evenly over 20 years.

The advantage of this option is that pipe

replacement needs can be assigned to each year

in the estimation period according to the

projected aging of the transmission and

distribution network. The disadvantages are that

the assumptions required to build the model

represent a simplification of reality and that the

estimates substitute actual needs identified by

water systems with modeled needs.

For option 2, the need for transmission lines

and distribution mains was estimated using a

pipe inventory model instead of the DWINS

results. The steps involved in modeling the

replacement of pipe include (A) estimating the

current inventory of pipe, (B) estimating its

vintage (i.e., the year in which each mile of pipe

was installed), (C) estimating the year the pipe

must be replaced as a function of its age, and

(D) estimating the cost of replacing the pipe.

28 American Water Works Association, Dawn of the Replacement

Era: Reinvesting in Drinking Water Infrastructure, May 2001.
33

Methods for Estimating Needs and Spending for Drinking Water

A. The current inventory of distribution

mains is estimated using data from the

1995 Community Water System Survey

(CWSS). The CWSS reports the miles of

distribution mains in place for a

representative sample of community water

systems. The total miles of pipe in place is

estimated to be approximately 1.5 million

miles.

The CWSS does not ask water systems to

provide data on transmission lines. To

account for transmission lines, the miles of

pipe need reported in the DWINS for

transmission lines are compared to the

miles needed for distribution lines. The

ratio of total miles of pipe to distribution

mains in the DWINS is 1.25. Therefore,

the length of distribution mains reported

in the CWSS is multiplied by 1.25 to

produce an estimate of the total inventory

of pipe currently in place: 2.0 million miles.

To verify the model, the results were

compared to the AWWA estimate of pipe

inventory for large systems serving over

50,000 people.29 AWWA’s estimate of

650,000 miles for these systems compares

favorably to the model’s estimate of

610,000 miles.

B. To approximate the age of the current

inventory of pipe, the model used the age

distribution of replacement pipe values

reported for 20 cities in the AWWA report

Dawn of the Replacement Era.

30 While the 20

cities in the sample were not selected at

random, the cities likely represent a broad

range of systems of various ages from

across the country. More importantly, the

study provides the only available data on

the age of pipe from a number of systems.

The analysis assumed that the age of pipe

nationally is distributed identically to the

age of pipe in the 20 cities in the AWWA

report. Figure 2–11 shows the assumed

distribution of the age of the pipe

currently in inventory.

C. Age is an important determinative

factor in governing when pipe must be

replaced. This method assumed that pipes

installed before 1910 last an average of 120

years. Pipe installed from 1911 to 1945 are

assumed to last an average of 100 years.

Pipe installed after 1945 are assumed to

last an average of 75 years. In estimating

when the current inventory of pipe will be

replaced, the model assumes that the

actual life span of the pipe will be

distributed normally around its expected

average life; that is, pipe expected to last 75

years will last 50 to 100 years, pipe

expected to last 100 years will last 66 to

133 years, and pipe expected to last 120

years will last 80 to 160 years.

This assumption greatly simplifies reality,

as the deterioration rates of pipe will vary

considerably as a function of climatic

conditions, pipe material, soil properties,

and corrosiveness of the drinking water.

Pipe of the same material, for example,

can last from 15 years to over 200 years

depending on the soil characteristics alone.

In the absence of data that would allow

for the development of a national model

to estimate pipe life (i.e., accounting for

local variability of pipe deterioration), the

application of a normal distribution to an

average life expectancy provides a

reasonable approximation of replacement

rates.

29 American Water Works Association, Infrastructure Needs for

the Public Water Supply Sector, December, 1998.

30 American Water Works Association, Dawn of the Replacement

Era: Reinvesting in Drinking Water Infrastructure, May, 2001.
34

Figure 4–1: Pipe Replacement Model Replacement Need Estimate ;	*, 7(
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6	

Methods for Estimating Needs and Spending for Drinking Water

In this analysis, when pipe reaches the end

of its life, based on the year of its

installation and its expected life span, it is

removed from inventory and replaced. The

model thus provides an estimate of the

total amount of pipe that must be replaced

over the next 20 years as well as an estimate

of the amount of pipe that must be

replaced each year. (Note: the model

actually provides estimates of the amount

of pipe required through 2075).

The pipe replacement model considers one

factor: physical deterioration. The model

does not account for other factors, most

notably inadequate capacity, that may have

equal importance to or greater importance

than deterioration in determining pipe

replacement rates. In the 1999 Drinking

Water Needs Survey, many systems cited

inadequate capacity to serve existing

consumers as the reason for pipe

replacement. As communities grow, pipe

installed decades ago can no longer deliver

the quantity of water necessary to satisfy

the present demand—let alone future

growth. Even though the physical

condition of the pipe may be excellent, its

lack of capacity requires its replacement.

The use of a normal distribution around

the average design life may unintentionally

account for some degree of replacement

arising from under-capacity. This method,

however, likely understates the true pipe

replacement need due to the exclusion of a

capacity-related variable.

D. The total capital need for transmission

lines and distribution mains is calculated by

multiplying the length of pipe replaced in

parts A through C by the cost per foot of

pipe. The cost per foot, derived from the

DWINS, is $58.1, including valves, meters,

and other pipe-related equipment that are

installed with the pipe. Figure 4–1 shows

the model’s estimate of the cost of the

pipe that will need to be replaced each year

through 2075. The last year of the

estimation period, 2019, is marked with a

line on the graph.
35

Methods for Estimating Needs and Spending for Drinking Water

The simple aging model applied to the

historical inventory of pipe reveals that

most of the projected replacement needs

occur beyond the 20-year period of this

analysis—with peak annual replacement

costs of $11.4 billion occurring around

2040. According to the model, most of the

pipe replacement needs occur beyond the

next 20 years. Through 2019, the total cost

of replacing transmission lines and

distribution mains is $52 billion. The cost

increases to $249 billion if the timeframe is

extended to 2029. Through 2075, the cost

is over $540 billion. This finding helps to

explain the relatively low pipe replacement

needs that are forecast to occur within the

estimation period under option 2.

3. Under option 3, the analysis applies a

constant replacement rate to the total inventory

of pipe, as determined under option 2. This

method assumes that pipe will require

replacement every 50, 75, or 100 years (which

translates into replacement rates of 2 percent/

year, 1.3 percent/year, and 1 percent/year,

respectively). The total inventory of pipe is

multiplied by the replacement rate to estimate

the annual replacement need. The amount of

pipe is then multiplied by the average cost per

foot as derived from the Needs Survey. Option

3 uses the 1999 Needs Survey data, with an

adjustment for underreporting, to estimate nonpipe needs.

4. Option 4 uses the estimate from the AWWA

survey of pipe replacement needs.31 In this

study, AWWA estimated that the total pipe

replacement need over the next 20 years is $352

billion. The methods AWWA used to obtain

this estimate are similar to those discussed under

option 3, except that AWWA used different

estimates of total inventory and cost per foot.

Option 4 uses the 1999 Needs Survey, as

adjusted for underreporting, to estimate nonpipe needs.

4.3 Allocate Capital Investment Need by

Year

To apportion the total capital investment need,

including all pipe and non-pipe components, over

the estimation period, some scenarios use the

distinction between current and future needs

identified in the 1999 Needs Survey. Current

investment needs are spread evenly over the 2000–

2003 period—i.e., 25 percent of the current need is

purchased each year through 2003. The future need

is then spread evenly over the next 16 years, or 6.25

percent per year. There is no empirical basis for

these timeframes other than that they serve to

distinguish between current and future needs. The

cost of complying with recently promulgated or

proposed regulations is spread out over the next 5

years, or 20 percent per year through 2004.

Alternate scenarios distribute non-pipe needs

evenly over the 20-year period. These scenarios may

provide a more realistic investment profile, given that

the current/future split would have systems investing

at a rate far greater than present levels. However,

this approach ignores the timing of the needs as

identified and documented by water systems for the

Needs Survey.

4.4 Calculate Financing Costs

While some systems may purchase

infrastructure out of current revenues, many will

finance at least a portion of the purchase through

borrowing. According to the 1995 Community

Water System Survey (CWSS), approximately 35

percent of the capital purchased between 1987 and

1995 was financed through borrowing from private

sources or through government loans.

31 American Water Works Association, Infrastructure Needs for

the Public Water Supply Sector, December, 1998.
36



  	



	

Methods for Estimating Needs and Spending for Drinking Water

To estimate the cost of financing the capital

investment, the model makes the following

assumptions:

1. Systems will rely on government loans or

private sector borrowing to finance 35 percent

of the capital investment. While the share of

capital investments financed may increase above

the historical rate as the need for investment

grows (although some systems would increase

revenue by increasing user rates), the analysis

assumes the historical rate would continue. This

assumption will tend to produce conservative

estimates of the cost of capital. As an

alternative option, the analysis assumes that in

response to the greater need for capital

investment, systems will increase the proportion

of needs that are financed to 75 percent.

2. Systems will borrow at an average nominal

interest rate of 5.9 percent, which, with an

annual inflation rate of 2.8 percent, yields a real

interest rate of 3.0 percent. The nominal interest

rate is derived from an average of the Federal

Reserve Bond Buyer Index for general

obligation debt over the past 10 years. The

annual inflation rate is determined by taking the

average rate of increase in the construction cost

index over the last 10 years.

3. The terms of the loans will be 20 years. As

an alternative option, the term of the loans will

be 30 years.

4. Systems will make constant payments over

the life of the loan. (For the sake of simplicity,

it was assumed a single payment is made each

year.) The payment is given by:

where:

p = the amount of the annual payment;

k = the value of the infrastructure

purchased;

r = the real interest rate; and

n = the duration of the loan.

5. The amount not financed is paid for in the

year in which the infrastructure is purchased.

Because a portion of the total need is purchased

each year over the 2000–2019 period, and because a

portion of each year’s purchase is financed over a 20

year period, the total cost of the capital, including all

interest and principal payments, is not paid for in full

by 2019. For example, capital purchased in 2019 that

is financed with a loan will not be paid for in full until

2038. Estimates of the capital payments (2000–2019)

for new infrastructure range from $178 billion to

$475 billion with a point estimate of $310 billion

($15.5 billion per year).

 4.5 Estimate Current Spending

4.5.1 Capital Spending

In order to calculate the gap, projected payment

needs are compared to current spending. To quantify

the relationship between needs and spending over

time, the analysis takes current spending, calculated as

the average spending over the last 10 years, and

assumes no real growth. The spending projections

are not an estimate of what spending will be; rather,

they are simply a baseline to which the projected

need may be compared (Figure 4–2).

By holding capital spending constant, the

analysis describes how the projected need compares

to current spending, for example, if the projected

need is $13.2 billion per year, how does that compare

to what water systems presently spend? The method

implies that systems would spend the same resources

they spend today without making assumptions about

how they would increase (or decrease) their spending
37

#


.#%

















-

(

Figure 4–2: Projected Drinking Water Capital Spending (adjusted for privates and DWSRF ineligibilities

for 2000 –2019)

Methods for Estimating Needs and Spending for Drinking Water

with regard to need. This is equivalent to how OMB

and CBO project discretionary spending for baseline

budget estimates.

The level of certainty associated with the

annualized projections of spending, and thus the

funding gap, decreases considerably over the 20-year

estimation period. To a large extent, this decline owes

to the assumption that spending will remain constant

over the next 20 years. This assumption likely will

underestimate the actual future spending. Actual

spending on capital should reflect the need for such

spending. Therefore, if the expectation that a large

portion of the nation’s capital stock will require

replacement is correct, then this prediction should be

mirrored in the spending data: that is, water systems

will need to, and thus will, spend more to replace or

operate and maintain an increasingly deteriorated

capital stock. The spending projections will not

capture the increased rates of spending that

presumably will occur in response to the aging capital

stock. However, the method provides a baseline

against which to compare the need for greater

investment with current levels of spending.

An alternative option would increase spending

based on a linear regression of historical rates. This

method, however, should not be considered, in a

technical sense, a baseline for spending. The problem

is that the real growth of the last 10 to 20 years

stems from the decisions of systems regarding their

needs. These are essentially policy decisions—and if

the spending projections assume real growth based

on historical trends, then the projections would

reflect future policy decisions. This, in turn,

complicates the evaluation of the future need

predicted by the model as the analysis would

compare future need to some unknown set of policy

decisions, rather than to the more straight-forward

baseline of current spending. Also, if the analysis

reveals that no capital gap exists, it then could be

reasonably, but erroneously, inferred that the status

quo for spending would suffice to meet future capital

investment needs. This conclusion, however, would

ignore the fact that in reality systems would need to

increase their spending to eliminate the gap.
38

The method for estimating current spending is

as follows:

1. The first step is to estimate the amount of

capital that would be purchased. Government

spending for drinking water data from the

Congressional Budget Office’s report Trends in

Public Infrastructure32 forms the basis of the

projections. Data on government spending on

infrastructure for 1977 through 1995 are

adjusted to constant dollars using the

construction cost index, published by the

Engineering News-Record. Government

spending is increased by 1/3 to account for

private sector spending, as described earlier. This

adjustment is based on the ratio of households

served by public and private systems, as

described in the November 1998 Regulatory

Impacts Analysis of the Stage 1 Disinfection ByProducts Rulemaking analysis.

2. Capital spending is then adjusted to account

for “unallowable” spending. This adjustment is

necessary so that the analysis can compare the

needs from the Needs Survey to the spending

data. Without this adjustment, the spending data

would contain spending on projects that would

not have been accepted by the Needs Survey

due to their ineligibility for Drinking Water State

Revolving Fund (DWSRF) assistance. Such

projects include dams, raw water reservoirs,

future growth, and fire flow. Consequently, the

spending data are reduced by 20 percent, based

on a review of 20 capital improvement plans

that were submitted by water systems for the

1999 Needs Survey. It is important to recognize

that although water systems may have

considerable capital needs related to DWSRF

ineligible projects, the gap analysis excludes these

needs.33

4.5.2 Capital Payments

The estimate of capital spending is a projection

of the annual investment in the capital stock based on

an average of the last ten years. As with the future

capital need, systems may choose to finance a

portion of this investment. In order to compare

future needs to the projection of current spending, it

was assumed that the projected spending would be

financed in a similar manner: that is, 35 percent or 75

percent would be financed at a real interest rate of 3

percent per year over a 20- or 30-year period. To

account for debt service payments for capital

purchased before 2000, this method assumes that

past capital purchases were financed in a similar

fashion. These payments are included in both

current spending and the total need because the

future need will include this debt service on past

investments.

4.6 Estimate the Total Capital Payment

Gap

The annual payment gap is the difference

between the estimated payment need and current

spending in each year. The total gap over the 20

years is the sum of the annual gaps. This analysis

estimates that the drinking water capital payment gap

is between $0 billion and $267 billion with a point

estimate of $102 billion34 in the no revenue growth

scenario (Figure 4-3), and it estimates that the gap is

between $0 billion and $205 billion with a point

estimate of $45 billion35 in the revenue growth

scenario (Figure 4-4). Using all of the possible

Methods for Estimating Needs and Spending for Drinking Water

32 Congressional Budget Office, Trends in Public Infrastructure,

May 1999.

33 By statute, the Needs Survey is used to allocate DWSRF

monies to the states. In general, the eligibility criteria developed

for the DWSRF are intended to promote the public health

objectives of the Safe Drinking Water Act.

34 The actual range is $-17 to $267 billion with a point estimate

of $102 billion. Under the assumptions used for certain

scenarios, the models predict a surplus of infrastructure funds,

or rather, a negative gap. In these scenarios, total spending and/

or revenues will exceed the total need over the next 20 years.

The report excludes these negative values in the text, because

systems generally would not collect revenues in excess of their

current estimated infrastructure needs. However, it should be

noted that doing so would free infrastructure funds for

situations where gaps remain.

35 The actual range is $-94 to $205 billion with a point estimate

of $45 billion. See Footnote 34 for further explanation.
39












































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01"
 23

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Figure 4-3: Capital Payment Gap (Average No Revenue

Growth Scenario)






































.#%$,-	

01"
 23

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Figure 4-4: Capital Payment Gap (Average Revenue

Growth Scenario)

Methods for Estimating Needs and Spending for Drinking Water

combinations of assumptions described earlier, the

analysis generated 216 permutations for estimating

the capital payment gap. The extreme values of these

scenarios comprise the lower and upper limits of the

range. A point estimate was obtained by simply taking

an average of all of the scenarios.

In understanding the significance of the

findings, it is important to recognize that the analysis

holds spending constant based on the average

spending from the last ten years. Therefore, any

funding gap that is forecast by the analysis ought not

to be considered an inevitability, but rather a

potential outcome should water systems not make

the investments that will be required to replace and

maintain their aging capital stock.

4.7 Estimate the Operations and

Maintenance (O&M) Gap

Developing a defensible, quantitative

relationship between O&M needs and capital stock

presents a challenging task. However, as discussed in

Chapter 2, it is important not to discount the

significance of O&M needs when discussing the

financial viability and operating challenges

confronting drinking water and clean water systems.

Therefore, this analysis attempts to quantify the

O&M needs, spending, and gap.

4.7.1 General Steps–O&M Needs

The methods for estimating the difference

between O&M needs and spending involves three

primary steps.

1. Estimate annual operations and maintenance

needs (O&M) as a function of the capital stock,

which itself is a function of the projected

capital need.

2. Using data from the Congressional Budget

Office, assume that current levels of O&M

spending will continue through the estimation

period.

3. Compare the annual need for O&M to

spending. The difference is the annual gap.

4.7.2 Estimate O&M Needs

The analysis assumes that O&M needs are a

function of the future capital stock. The projection

of future O&M needs involves three steps.
40

1. The analysis quantifies the historical

relationship between O&M spending and the

total value of the drinking water capital stock.

The Census Bureau provides data on O&M

spending. The data of the drinking water capital

stock were obtained from the Bureau of

Economic Analysis (BEA). The data cover the

period from 1979 to 1997 and are limited to

publicly owned water systems. These data are

increased by 1/3 to account for privately owned

systems.

O&M spending is calculated as a proportion of

the total capital stock for each year from 1979

through 1997. The historical relationship

between O&M spending and capital stock is

projected through 2019, using a simple linear

regression. The model predicts O&M spending

as a share of the capital stock to be 11.9 percent

in 2000, and projects that the proportion will

increase only slightly to 12.4 percent by 2019.

Alternative scenarios adjust this relationship to

phase in a 10 percent efficiency increase over a

10-year period. Anticipated efficiencies include

staff reductions, outsourcing, consolidation, and

other operational improvements in the industry,

although these factors are expected to be

somewhat offset by increased demands related

to an aging infrastructure.

2. The next step is to estimate the future capital

stock. The capital stock in any given year is

equal to the capital stock in the previous year

plus new investment minus depreciation:

Kt

 = K

t-1

 + It - D

t-1 Kt

 is the capital stock in period t,

I

t

 is capital investment (i.e., need) in

period t, and

D

t-1

 is depreciation in period t-1.

The model starts with the current capital stock.

New investment is equal to the capital need

estimated in steps 1 and 2, which is added to the

current stock. Depreciation is then deducted.

Data from BEA are used to estimate annual

depreciation of the net capital stock. BEA

provides data on depreciation for publicly

owned systems, which is increased by 1/3 to

account for privately owned systems. A

depreciation rate is estimated as a proportion of

the net capital stock. As with the O&M

spending data in the previous step, a linear

model is used to project the depreciation rate

through 2019. Annual depreciation is then

calculated as the product of the depreciation

rate and the net capital stock. The net capital

stock depreciates at approximately 1.5 percent

per year.

3. The final step calculates the annual O&M

need as the product of the O&M percentage

calculated in the first step and the capital stock

estimated in the second step.

4.7.3 O&M Spending

The method for estimating baseline O&M

spending is similar to that of capital spending, except

that there are no DWSRF eligibility adjustments for

O&M spending. The analysis assumes that all O&M

spending will be required to ensure the continued

provision of drinking water. Some portion of the

O&M spending will occur for DWSRF ineligible

projects (e.g., maintenance of dams). However, the

additional assumptions required to eliminate ineligible

O&M spending from the analysis would not be

justified, given that these expenditures likely represent

a small fraction of total O&M spending. As with

capital spending, the O&M spending is held constant,

and thus the same caveats apply that were discussed

earlier.

Methods for Estimating Needs and Spending for Drinking Water
41






































.#%$,-	

01"
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)
$,-

Figure 4-5: O&M Gap (Average No Revenue Growth

Scenario)






































.#%$,-	

01"
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Figure 4-6: O&M Gap (Average Revenue Growth Scenario)

4.7.4 The O&M Gap

This analysis estimates that the drinking water

O&M gap is between $0 billion and $495 billion with

a point estimate of $161 billion36 in the no revenue

growth scenario (Figure 4-5), and it estimates that the

gap is between $0 billion and $276 billion with a

point estimate of $0 billion37 in the revenue growth

scenario (Figure 4-6). As with the methods for

estimating the capital gap, the analysis generated 216

permutations for estimating the O&M payment gap

based on all of the different combinations of

scenarios resulting from the different assumptions

outlined earlier. The extreme values of these

scenarios comprise the lower and upper limits of the

range. A point estimate was obtained by taking an

average of all of the scenarios.

It is important to recognize that the O&M gap

exists as an artifact of the methods used to estimate

the capital gap. The O&M needs increase

substantially over the estimation period, due to the

extent to which the capital stock increases. The

capital stock, in turn, increases as a result of the new

capital investments needed by water systems.

However, the size and timing of these capital

investments are determined by the methods used to

Methods for Estimating Needs and Spending for Drinking Water

estimate the capital need. Also, the O&M gap will be

larger if capital needs are purchased earlier in the

projection period (i.e., applying the current/future

distinction from the Needs Survey). Purchasing

capital early in the estimation period increases the

capital stock. This, in turn, will increase the O&M

need throughout the period.

Also, although we would expect O&M needs to

increase in response to an aging capital stock, the

method for estimating O&M needs uses the

historical relationship between O&M spending and

capital stock as the basis for projecting future costs.

Thus, while O&M needs increase, as will likely occur

given the aging of the nation’s infrastructure, the

driver for this increase in the analysis is the annual

capital need, and not an accelerating replacement

rate of the existing stock. The constraints imposed

by the limited data prevent the development of a

quantifiable relationship between O&M needs and

36 The actual range is $-67 to $495 billion with a point

estimate of $161 billion. See Footnote 34 for further

explanation.

37 The actual range is $-286 to $276 billion with a point

estimate of $-58 billion. See Footnote 34 for further

explanation.
42

the national capital stock inventory; for this reason,

the analysis uses the method described earlier.

In addition, the analysis assumes that the

historical proportion of O&M spending to capital

stock is a reasonable predictor of the future

proportion of O&M spending to capital stock. One

complicating factor is that new capital stock would

require less O&M spending than the historical

projections would predict (i.e., new equipment

requires less O&M than older equipment).

Alternatively, the O&M spending required for the

existing capital might increase at a faster rate than

that predicted by historical trends, particularly if a

large proportion of the capital stock reaches an age

at which greater O&M must be invested. The

difficulty of quantifying these factors necessitates the

simplifying assumption that the historical rate of

O&M spending to capital stock represents a

reasonable, but approximate, basis for estimating

O&M needs. It is significant to note that the clean

water and drinking water analyses assume that

systems will realize efficiencies in O&M that will

reduce the proportion of O&M spending to net

capital stock. Thus, the analyses presume that

improvements in O&M practices will offset the

effects of an aging capital. Without this assumption,

the O&M needs would increase greatly in magnitude

over the estimates presented here.

In understanding the significance of the

findings, it is important to recognize that the analysis

holds spending constant based on the average

spending from the last ten years. Therefore, any

funding gap that is forecast by the analysis ought not

to be considered an inevitability, but rather a

potential outcome should water systems not increase

spending to meet increased levels of O&M needs.

Methods for Estimating Needs and Spending for Drinking Water
43

Conclusion

Conclusion

5.0 Findings

This report estimates the gap between the

projected need and current spending for clean water

and drinking water infrastructure over the next 20

years using data available from EPA, the Census

Bureau, and the Congressional Budget Office. In

broad terms, the gap analysis concludes that clean

water and drinking water systems will need to use

some combination of increased spending and

innovative management practices to meet projected

needs. This analysis estimates that the clean water

capital payment gap is between $73 billion and $177

billion with a point estimate of $122 billion in the no

revenue growth scenario, and it estimates that the

capital payment gap is between $0 billion to $94

billion with a point estimate of $21 billion38 for the

revenue growth scenario. The analysis estimates that

the drinking water capital payment gap is between $0

billion and $267 billion with a point estimate of $102

billion39 in the no revenue growth scenario, and it

estimates that the gap is between $0 billion and $205

billion with a point estimate of $45 billion40 in the

revenue growth scenario.

It is important to recognize that the funding

gaps occur only if capital and O&M spending

remains unchanged from present levels. This

assumption clearly understates future spending and

ignores other measures, such as asset management

processes or capacity development, that systems

could adopt to reduce both capital and O&M costs.

In reality, increasing needs will likely prompt

increased spending. However, the analysis presents

an approximate indication of the funding gap that

will result if we ignore the challenge posed by an

aging infrastructure network; a significant portion of

this infrastructure network is beginning to reach the

end of its useful design life.

A panel of industry experts evaluated a draft of

this report, and to the extent possible, the panel’s

critiques and comments are incorporated into this

final report. The major points made by the reviewers

are summarized in Appendix B. The reviewers

agreed that the Gap Analysis provides an important

starting point for the discussion about the magnitude

of drinking water and clean water infrastructure

funding issues. The general consensus was that the

document represents a reasonable effort to quantify

the infrastructure gap, given the limitations imposed

by the available data. This praise, however, also

contains the principal criticism of the analysis; the

poor quality of the data severely constrains any effort

to quantify the infrastructure funding gap with great

accuracy. EPA acknowledges the uncertainty

associated with the analysis. Nonetheless, in

proposing these provisional estimates, the report

encourages a policy discussion of the challenges

confronting the nation’s clean water and drinking

water systems. Most experts familiar with the

industry agree that these challenges must be met if

we are to continue to advance environmental and

public health protection.

5.1 Suggestions for Future Research

In developing this analysis and reading the

comments from the peer reviewers, EPA noted that

further research would help future efforts to quantify

the infrastructure gap. Although far from an

exhaustive list, the research areas identified below

38 The actual range is $-39 to $94 billion with a point estimate

of $21 billion. Under the assumptions used for certain

scenarios, the models predict a surplus of infrastructure funds,

or rather, a negative gap. In these scenarios, total spending

and/or revenues will exceed the total need over the next 20

years. The report excludes these negative values in the text,

because systems generally would not collect revenues in excess

of their current estimated infrastructure needs. However, it

should be noted that doing so would free infrastructure funds

for situations where gaps remain.

39 The actual range is $-17 to $267 billion with a point

estimate of $102 billion. See Footnote 38 for further

explanation.

40 The actual range is $-94 to $205 billion with a point

estimate of $45 billion. See Footnote 38 for further

explanation.
44

offer opportunities to improve the estimates.

• The inventory of the nation’s clean water and

drinking water capital stock and the condition

of the capital stock should be more fully

explored. Data providing an improved picture

of the remaining life of these critical capital

assets and data identifying the different classes

of inventory (e.g., treatment, pipe, storage)

would provide a foundation for progressing to

the next step—assessing the condition of the

nation’s infrastructure. These data would greatly

improve decision-making about investment

needs for maintaining, upgrading, and expanding

infrastructure.

• The relationship between O&M needs and

capital stock is not fully understood. A more

refined approach than the one adopted in this

analysis would investigate how O&M needs vary

as a function of gross (not net) capital stock and

the age or condition of the capital stock. These

data, other than in purely speculative form, are

not yet available.

• Clean water and drinking water systems will

incur significant costs over the next 20 years as

they expand capacity to serve current and future

growth. Methods for estimating capital

investment needs associated with growth and

changes in service standards were excluded from

the analysis.

• This analysis would benefit from research into

an array of issues that ultimately will determine,

or at least influence, the scale of future capital

investment needs. These issues will also

determine how future capital investment needs

are met. These issues include, but are not

limited to, topics such as the following:

• Implementation of best management

practices, including asset management

processes and capacity development

• Restructuring, integrating, and

amalgamating service providers to seek

economies of scale in the provision of

services

• Pricing policies and their effect on

demand elasticity for water

• Demographic shifts within the United

States

• Efficiencies gained or lost due to the

installation of the latest technology

• Trends in operating costs (e.g., of

chemicals and energy)

• Criticality analysis (i.e., which

components of a system should take

precedence for investment due to age,

condition, and importance)

• Effects of non-like-for-like replacement

of assets

Conclusion
45

Comparing the Gap between Clean Water and Drinking Water: Numbers and Methodologies

APPENDIX A

Comparing the Gap between Clean Water and

Drinking Water: Numbers and Methodologies

1.0 Comparison between the Clean Water

and Drinking Water Capital Payment Gap

This analysis estimates that the clean water

capital payment gap over the next 20 years is $122

billion in the no revenue growth scenario and $21

billion in the revenue growth scenario. The analysis

estimates that the drinking water capital payment gap

is $102 billion in the no revenue growth scenario and

$45 billion in the revenue growth scenario. These

figures represent point estimates within a range, as

described in Chapters 3 and 4.

The methods used in this analysis (e.g., the

modeled replacement need) preclude the calculation

of standard errors about these estimates to determine

whether the difference between the drinking water

and clean water gaps are statistically significant. The

difference in gaps likely reflects differences in the

methods applied by the analyses. The following

sections discuss the similarities and differences in the

methods used by the clean water and drinking water

analyses in calculating the funding gap.

The methods for estimating the capital gap for

clean water and drinking water, as described in

Section 5.1, were harmonized to the extent to which

the data allowed for consistencies between the two

analyses. As Section 5.2 explains, however, limitations

of the available data necessitated the use of divergent

methods for estimating needs and spending.

1.0.1 Similarities in Methods

With respect to the similarities, both analyses

used their respective Needs Surveys as a starting point

for identifying capital needs. The clean water analysis

used the results from the 1996 Clean Water Needs

Survey (the next survey is due out in 2002), while the

drinking water analysis used the data from the 1999

Drinking Water Needs Survey. These surveys

produce highly credible data, as each need submitted

by a system was accompanied by documentation

describing the purpose of the project. The

documentation requirement imparts a conservative

bias to the estimates, but it also allows EPA to

determine whether each need meets the eligibility

criteria for State Revolving Fund assistance; this is

critical for the drinking water program, as the law

requires EPA to use the survey results to allocate SRF

monies to the states.

The treatment of spending data is also similar

between the clean water and drinking water analyses.

Data from the Congressional Budget Office and the

Census Bureau are used to determine historical levels

of spending on capital. The drinking water analysis,

however, applies an adjustment factor to account for

privately owned systems and Drinking Water State

Revolving Fund (DWSRF) ineligible projects. Both

of the analyses hold spending constant over the

estimation period, which allows for the comparison

of projected needs to baseline spending. Both

analyses also use a real rate of growth of three

percent when considering revenue growth scenarios.

1.0.2 Differences in Methods

1.0.2.1 Capital Needs

The analyses differ in the methods used to

calculate capital needs. Clean water capital need

estimates are derived from a single method that

determines needs using the Clean Water Needs

Survey, a Sanitary Sewer Overflow needs estimate,

and a modeled replacement need estimate based on a
46

Comparing the Gap between Clean Water and Drinking Water: Numbers and Methodologies

constant replacement rate for the net capital stock.

The clean water analysis assumes that the needs

survey fails to capture the true extent of the 20-year

need associated with replacement. The analysis

considers a range for many key variables; for

example, the analysis considers scenarios in which

clean water systems finance 75 percent, 85 percent,

or 95 percent of capital needs.

The drinking water estimates use four

approaches to calculate replacement needs. A full

description can be found in Chapter 4. One option

adjusts the results of the Drinking Water

Infrastructure Needs Survey based on the results of a

follow-up survey. Three other options replace the

DWINS estimates of transmission and distribution

needs with estimates from pipe inventory models.

The use of these replacement estimates differs

from the clean water approach in that only the pipe

portion of the total infrastructure need is modeled.

Pipes comprise the majority of a system’s capital

stock, and thus modeling the replacement of pipe

likely captures most of the needs associated with

replacing old and deteriorated equipment. The nonpipe needs are derived from the Needs Survey with

an adjustment for underreporting. The difficulty of

distinguishing between new and replacement needs in

the Needs Survey explains the decision not to model

non-pipe needs in a manner similar to the clean water

approach. A replacement term could be developed

for these needs; however, the documented needs

from the Needs Survey were considered a more

accurate, and less speculative, measure of non-pipe

needs.

It is important to note that the range of needs

and gaps are provided to explicitly acknowledge

variations within the estimates, but are not intended

to support comparative analysis between the clean

water and drinking water industries. The drinking

water analysis was able to use data sets that were not

available to clean water, e.g., data sets of pipe

inventory and age of assets. These data allowed

drinking water to use four different methods to

estimate capital needs and vary assumptions within

each method, whereas the clean water analysis used a

single method and varied assumptions within that

method. The broader array of methods available to

the drinking water analysis generated a broader range

of needs and gaps. As such, the resulting ranges

provide insight into the impact of varying

assumptions within each industry, but the data and

methods cannot be used to conduct a valid

comparison of the funding gaps facing the clean

water and drinking water industries.

1.0.2.2 Financing Costs

The clean water and drinking water methods

assume that systems will finance a proportion of

their capital needs and spending. The drinking water

analyses use a real interest rate of 3.0 percent, while

the clean water analyses consider real interest rates

of 2.5 percent, 3.0 percent, and 3.5 percent. The

drinking water analysis assumes that the average loan

term is 20 years or 30 years, while the clean water

analysis considers average loan terms of 20 years, 25

years, and 30 years. The drinking water analysis

assumes that water systems will finance either 35

percent or 75 percent of their capital needs; the

clean water analysis assumes that clean water systems

will finance 75 percent, 85 percent, or 95 percent of

their capital needs.

1.1 Comparison between the Clean Water

and Drinking Water and O&M Payment

Gap

The analysis estimates that the O&M gap for

clean water over the next 20 years is $148 billion for

the no revenue growth scenario and $10 billion for

the revenue growth scenario. The drinking water

O&M gap is $161 billion in the no revenue growth

scenario and $0 billion41 in the revenue growth

scenario. These figures represent point estimates

within a range, as described in Sections 3 and 4.
47

Comparing the Gap between Clean Water and Drinking Water: Numbers and Methodologies

1.1.1 Similarities in Methods

The clean water and drinking water analyses use

similar approaches for estimating O&M needs. Both

analyses assume that the ratio of O&M spending to

net capital stock will remain constant through the

estimation period, and this ratio is multiplied by the

projected capital stock to calculate O&M spending

for each of the next 20 years.

The treatment of spending data is also similar

between the clean water and drinking water analyses.

Data from the Congressional Budget Office and the

Census Bureau are used to determine historical levels

of spending on O&M. Both of the analyses hold

spending constant over the estimation period, which

allows for the comparison of projected needs to

baseline spending. In the revenue growth scenarios,

both analyses use a real rate of growth of three

percent.

1.1.2 Differences in Methods

There are two major factors that explain the

difference in drinking water and clean water O&M

estimates. First, much of the difference between the

O&M needs for drinking water and those of clean

water results from the different methods used to

allocate capital needs over the estimation period. To

understand the meaning and validity of these results,

it is necessary to revisit the discussion in the previous

section.

In describing the methods used to calculate the

O&M needs, Chapter 4 cautioned that the drinking

water O&M gap may exist largely as an artifact of

the methods used to estimate the capital gap. For

clean water and drinking water, the O&M needs

increase substantially over the estimation period, due

to the extent to which the capital stock increases.

The capital stock, in turn, increases as a result of the

new capital investments needed by water systems.

It is important to recognize that the scale and

timing of new capital projects are determined by the

methods used to estimate the capital need. Under

one scenario for estimating the capital needs of

drinking water systems, the analysis applies the

current/future distinction from the 1999 Drinking

Water Needs Survey. The clean water analysis cannot

use this distinction, as the 1996 Clean Water Needs

Survey did not differentiate between current and

future needs. The clean water analysis, however, does

account for the timing of certain needs by using of a

replacement model that predicts the costs of

replacement will increase over the next 20 years.

The upper bound of the range for O&M needs

for drinking water greatly exceeds that of clean water

largely due to the timing of new capital investments.

In the upper bound scenarios, most of the new

capital investment occurs within the first 5 years for

drinking water, whereas the highest levels of

investment occur at the end of the estimation period

for clean water. The “front-loading” of needs means

that the drinking water capital stock increases

significantly over the first 5 years in contrast to the

steady, but more modest, increase in capital stock

(i.e., new capital needs) for clean water.

Thus, the upper limit of the O&M need for

drinking water is larger than for clean water, because

capital needs are purchased earlier in the projection

period. Purchasing capital earlier in the estimation

period increases the capital stock. This, in turn,

increases the O&M need throughout the period.

When the drinking water analysis distributes the

needs evenly over the 20-year period, the O&M gap

declines significantly.

41 The actual estimate is $-58 billion. Under the assumptions

used for certain scenarios, the models predict a surplus of

infrastructure funds, or rather, a negative gap. In these

scenarios, total spending and/or revenues will exceed the total

need over the next 20 years. The report excludes these

negative values in the text, because systems generally would not

collect revenues in excess of their current estimated

infrastructure needs. However, it should be noted that doing

so would free infrastructure funds for situations where gaps

remain.
48

Critiques and Comments from the Peer Review Panel

APPENDIX B

Critiques and Comments from the Peer Review Panel

1.0 The Peer Review Process

EPA submitted the methods and data used in

this analysis to a panel of peer reviewers drawn from

academia, think tanks, consulting firms, and industry.

The peer reviewers submitted more than 50 pages of

comments to EPA. In general, the reviewers found

that the analysis represented a commendable and

credible effort to quantify the infrastructure gap, but

this appendix summarizes the critiques and

comments of the peer review panel.

1.1 Major Points about the Capital

Estimates

The basic need estimates were based, in some

measure, on 1- to 5-year capital works programs

rather than 20-year assessments. Given the level of

documentation required by the Needs Surveys, some

form of adjustment is necessary. Experience with

capital works programs suggests that even with a 5-

year capital program, years 1-3 are usually sound, but

the proposals for years 4 & 5 fall-off as it is too far

away for people to focus on those needs. Therefore

it is common for models to take over from the

established plan as early as the fourth year and

definitely for the 5-20 year window.

When the gap analysis establishes future needs

for capital investment and O&M, it assumes that

historical investment trends will continue. This

assumption may be faulty. Significant additional

modeling to assess the sensitivity of investment

requirements to age, condition, and criticality would

shed light on the priority and risk-based nature of

decisions responding to the anticipated investment

spike.

The practice of adjusting historical

infrastructure expenditures to today’s dollars can

provide very misleading signals regarding asset

replacement. Original sites may have changed

markedly with respect to access, work site

congestion, or other cost drivers, and as a result, the

replacement cost of an asset may have increased.

For this reason, additional repair and/or operating

costs may be economical alternatives to replacement.

The data sets used in the analysis are, for the

most part, those that are generally used in a highlevel study of this nature. The findings of the

analysis paint a reflective, high-level picture. The use

of “useful life” matrices for water utility assets could

be greatly improved by moving towards “survival

curves” for various asset classes. The ‘Kanew’

technique (from an AWWA Research Foundation

project in the mid-1990’s) and the ‘Nessie Curve’

approach to investment decision-making are

reflected in the approach to the analysis. These

approaches form a good starting point for an

understanding of the investment waves, which will

travel through the utility in time. The report

generally postulates that the need to replace pipe will

generally echo the original installation wave.

However, while this is true for age-based

replacement strategies in which each pipe material

has the same lifecycle properties, it may not

adequately model the effects of non-like-for-like

replacement of assets that incorporates the effects

of innovation. Some innovations will result in

shorter or longer lifecycles.

Depreciation and replacement rates are not the

same thing. A composite depreciation rate (which

drives the estimates in this report) masks important

variations that are relevant to this analysis. An asset

can be fully depreciated on the books and still fully

functional, or an asset can have significant remaining
49

Critiques and Comments from the Peer Review Panel

book life and be unable to perform its service

function. There are alternate ways to calculate the

depreciation rate of a class of assets, some of which,

such as optimal deprival value, are based upon the

criticality of the asset to the operation of the system.

To properly value the asset base, criticality of riskbased factors should be featured in the calculation.

This change would improve the quality of the

estimates.

Comprehensive capital estimates should assess

the interaction between water infrastructure

investment and growth. Initial capital costs of

infrastructure and life cycle costs of infrastructure

can be significantly impacted by patterns of

urbanization.

This analysis fails to ascertain the overall impact

of regulations and how such changes in regulation

might impact costs factors associated with meeting

service and environmental objectives.

1.2 Major Points about the O&M

Estimates

It is generally accepted that the ratio of O&M

costs to capital investment increases as the system

ages. It is also true that as this aging infrastructure is

renewed, the O&M costs of the renewed system will

frequently be reduced. In this report, the estimates

for O&M may be reasonable on an aggregate basis,

considering that the analysis makes assumptions

based on the entire clean water and drinking water

industries. However, if certain components of these

industries, e.g., very small systems, are isolated for

analysis, then it might be argued that O&M needs are

higher for those groups than the pro rata portion of

the expenditures presented in the report.

The analysis develops a relationship between net

capital stock and O&M expenditures that is

problematic. While there may be a good correlation

between net capital stock and O&M at this time, and

while that relationship may hold for some time to

come, this relationship will almost certainly break

down when main replacement needs start to escalate.

Furthermore, the out-year O&M estimate is very

much influenced by the changes in capital stock. If

investment plans do not materialize in accordance

with the planned capital expenditures, the effect on

O&M expenses is difficult to model, if not

impossible. To the extent that relevant data is

available, it would be more telling to model O&M

expenditures as a function of gross capital stock and

separate the data between main and non-main

expenditures.

There may be a case for a significant reduction

in O&M costs, which may be achieved relatively early

in the modeling period. However, any reduction is

likely to come off a baseline that is almost certainly

trending significantly upwards. Further, some costs

such as energy and chemicals that are significant

elements in a utility’s cost structure may increase, not

fall. The mix of these cost components will vary

significantly depending upon the ‘age’ of the system

(in simplistic terms), the rate at which it is adding or

losing customers, and the ‘mix’ of assets employed

(network versus treatment). It is true that if old pipes

are replaced, O&M will decline. However, clean

water and drinking water systems will replace only a

small percentage of the nationwide pipe network

from 2000–2019. The bulk of the pipes in the system

will age but remain in place. As a whole, the pipe

network will be older, and therefore nationwide

O&M costs should increase.

The use of net capital stock as a predictor of

O&M is somewhat troubling. O&M is a variable cost

and capital stock is only one determinant. Demand is

the big variable and demand is a function of a range

of factors. Per-capita demand has flattened, and this

affects these ratios.

More attention should be paid to the impact of

cost reduction opportunities, in at least five areas:

efficiency practices (least-cost), technological

innovation (capital & O&M), market-based

approaches (bidding), industry restructuring

(consolidation), and integrated resource management

(supply and demand side).
50

Critiques and Comments from the Peer Review Panel

In the future, reserves will be tougher to

establish and maintain as operating costs increase,

and citizen backlash against rate increases may also

limit the appropriate accumulation of reserves for

capital replacement. In addition, states have become

more prescriptive regarding the establishment of

system development charges (impact fees and the

like).

1.3 Major Points about the Financing

Forecast

While a huge overnight change in the market

structure is unlikely, private sector finance in the

form of acquisitions, delegated services contracts,

build-operate-transfer, concessions, etc. will increase

over the period covered by the analysis. This may

reduce the cost of capital for some water utilities

because risk is deflected onto a third party (the

‘concessionaire’).

The suggestion that a significant portion of

clean water and drinking water spending must be

funded from revenues, i.e., from working capital,

should be seriously questioned. Any movements in

rate structures, demographic changes, funding of

unforeseen events, etc. may have a major impact

upon the ability of utilities to fund investments from

working capital. It is inevitable that some proportion

of costs will be financed, in order to ‘smooth-out’

the price shocks—shocks likely caused by treatment

plants rather than the mains networks. Consequently,

it is appropriate to recognize financing as a

mechanism without dealing with how that financing

will be achieved or supported (i.e. debt to equity

treatments, including the use of retained earnings)

ahead of the other report.

United States

Environmental Protection

Agency

Washington, DC 20460

Office of Water (4606M) Printed on Recycled Paper

www.epa.gov/safewater

EPA-816-R-02-020

September 2002