January 7, 2016
By Fred Greguras

The omnibus spending legislation (Consolidated Appropriations Act of 2016) enacted on December 18, 2015 includes a five year extension of the investment tax credit (“ITC”) for solar and an extension for the production tax credit for wind power generation. This action provides hope that someone in Congress, perhaps a climate change advocate who understands the importance for the environment as well as the economy, will be inspired to champion the same type of incentives for water projects. Improving water quality, mitigating scarcity and increasing supply in the U.S. are equally as important as reducing the demand for natural resources in energy generation. The effects of global warming may increase the water scarcity problem in California and elsewhere. Private sector financing can be a simpler, faster and a more viable alternative in many cases if such incentives are implemented, particularly for smaller projects.[1]

The ITC for solar provides a 30% tax credit for certain equipment and other personal property purchased and used in solar projects. Under the December, 2015 extension, the 30% tax credit will continue through 2019 and then decline gradually to 10% in 2022. Currently, equipment and other personal property used for water desalination, remediation, reclamation, storage or other water projects are not eligible property under the IRC § 48(a) (3)(A) categories or any other IRC § 46 investment credit category.

The 30% ITC and five year accelerated depreciation (“AD”) (rather than 25 year depreciation) have stimulated private sector financing of solar projects and are needed to attract private investment to water projects. Solar installations have grown in the U.S. at a compound annual rate of 76% since the ITC was implemented in 2006, according to the Solar Energies Industry Association.  The availability of the ITC and AD for water projects could be monetized for financings with tax equity investors which has been an important source of funding for the renewable energy sector.

The Public-Private Solution

Public water facilities have historically been funded by public financings such as bond issues rather than by private financings. Necessity may drive the authorization of private financing techniques for public facilities since general obligation (“GO”) or revenue bond issues to finance new or upgraded water facilities may simply not be feasible.

The passage by California voters of Proposition 1 in November, 2014 illustrates the difficulty of public funding of water facilities and why incentives are needed for private sector financing of water projects. It was the first state water bill approved by voters in almost 10 years.

Both the state and local governments may issue GO bonds under the California Constitution. However, state level bonds need to be approved only by a majority of voters in an election while local GO bonds must be approved by 2/3 of the voters and are rare. Local governments usually need to increase property taxes to repay the GO bonds to the extent permitted under Proposition 13, the 1978 proposition that limited property tax increases. California voters are unlikely to change the Constitution to make it easier to be taxed at the local level.

The 2/3rds voter approval requirement has made it very difficult for local governmental agencies to raise money for water projects using GO bonds and has caused a greater reliance on state level bonds. Spending under Proposition 1, however, requires matching funds from non-state sources in many cases which will continue to put pressure on local funding.

While Proposition 1 authorized $7.12B in GO bonds, it is not enough to solve the California water financing problem. A March, 2014 report, Paying for Water in California, prepared by the Public Policy Institute of California indicates that such funding will, best case, cover half of the total spending gap.

The concern over the water shortage in California has become so great that the state is supporting innovative long-term solutions such as the Carlsbad, California Desalination Project (“Carlsbad Project”) which began operations in December, 2015. The billion dollar project was built by a private company, Poseidon Water, and financed with over $700M in tax-exempt bonds with the rest of the financing by a private equity investor. The tax-exempt bonds were issued by the California Pollution Control Financing Authority on behalf of the project developer and the San Diego County Water Authority (“Water Authority”). The revenue stream for repayment to investors is a 30 year water purchase agreement with the Water Authority (“WPA”) similar to a power purchase agreement in the solar and wind energy sectors. The WPA provides a predictable source of revenue to make the numbers work for investors and provides the Water Authority with long term certainty for water costs and supply.

Financing Smaller Water Projects

Incentives at the national level such as a 30% ITC and five year AD are needed to attract private investment to smaller water facilities at the local level. An August, 2015 Congressional Research Services report (“CRS Report”) states that the majority of water infrastructure needs in the U.S. are for smaller projects in terms of the amount of the financing. As indicated, currently, equipment and other personal property used for water desalination, remediation, reclamation, storage or other water facilities are not eligible property for the ITC.

A water project must have a meaningful revenue stream (WPA, lease payments, water fees, etc.) and demonstrate creditworthiness in order to be viable to investors. Successful project finance depends on making the return on investment (“ROI”) numbers work for developers and investors with a high degree of predictability. The numbers must work when matching revenue streams against startup and recurring costs. The greater the ratio of equity to debt, the more likely a financing is feasible and the better the debt financing terms that are likely to be available.

California and other states can help solve the financing problem by authorizing the ITC and AD at the state level as well. States can also help make private financing more feasible by excluding property taxes on a water facility when owned privately. Eliminating sales and use taxes on purchases of equipment and other personal property used in the facility would also help make a financing more feasible since it would reduce the amount needed to be financed. There are other ways to reduce project costs such as for equipment, construction, operation and maintenance (“O&M”), taxes and financing costs like interest payments. For example, using “bankable” equipment reduces the cost of O&M; using an engineering and procurement contractor with a strong track record reduces construction costs and using the same financing team for multiple projects reduces transaction costs.

Consider the impact of the proposed federal incentives on the financing of a $40M water reclamation facility. The project entity monetises the ITC and AD with a tax equity investor. The tax equity investment would be about 40% of the $40M or $16M. Assume the private sponsor/developer makes an equity investment of 20% or $8M in order to satisfy investors requirements to have skin in the game. The beauty of a tax equity investment is that an investor only receives tax benefits and not a repayment stream. The remaining amount, $16M, would be debt financing. The amount of the debt financing becomes smaller because of the equity investments with a resulting smaller amount of debt service that is more likely to be covered by project revenue streams. In contrast, a public revenue bond financing would likely have to be for the full $40M and would be difficult to have a tax equity component because of the forbearance requirements of the tax equity investor and the constraints of the public financing process.

If a solar property is foreclosed on by the lender, the IRS will “recapture” the remaining tax credits that have not yet vested over the five-year period (20% of the total tax benefit per year). The AD deduction for the tax equity investor will cease upon a foreclosure. A tax equity investor does not want to lose any portion of the tax benefits because of the adverse impact on the projected ROI that was the basis of its investment. As a result, a tax equity investor wants the project lender to forbear exercising its foreclosure rights against the borrower during that period to avoid recapture. On the other hand, the lender wants the right to exercise its remedies in the event of a default by the borrower which creates a conflict between the interests of the project investors. This conflict is resolved by a forbearance agreement. Tax equity investors and lenders have developed a number of alternatives to absolute forbearance in renewable energy financings that mitigate the risks to both investors which can also be used in water project financings.

Financing Large Water Projects: WIFIA Program

The federal Water Infrastructure Finance and Innovation Act (“WIFIA”) financing program was enacted in June, 2014 for large water infrastructure projects throughout the U.S. The purpose of WIFIA is to provide credit assistance to such facilities that otherwise have difficulty in obtaining financing. Projects must be a minimum of $20M in cost to be eligible for credit assistance under WIFIA, except for a lower threshold for projects in rural areas. According to the CRS Report, WIFIA can be an important financing tool for large and costly projects but the majority of water infrastructure needs are for smaller projects. No projects have been financed under WIFIA since Congress has only provided start-up funding for the program but none for loans.

WIFIA will provide low-cost loans from the U.S. Treasury for up to 49% of a project’s cost. WIFIA loans are intended to be combined with other financing alternatives to enable public-private partnerships for financing water infrastructure. Projects must have a revenue stream and demonstrate creditworthiness to be eligible. This requirement should reduce the federal government’s risk and also encourage private investment. In December, 2015 WIFIA was amended to permit loans to be used in projects which are financed in part by tax exempt bonds. Previously, large projects using such financing such as the Carlsbad Project were not eligible for WIFIA loans. The amendment should make such loans more feasible since the interest cost is lower for tax exempt bonds and a private investor is likely to want to spread the financing risk of the cost of such a large project.

Tax equity investors are less likely to be interested in projects with extremely large costs involving public financing because they want to spread the investment risk across a portfolio of projects rather than one large project and the difficulty of negotiating acceptable forbearance provisions with public entities for the five year period of the ITC and AD.

Conclusion

Now is the time to become more innovative and promote and enable more private sector investment in public water projects by providing financing incentives instead of continuing to propose more income and property taxes and fees for public funding of water projects. Bond issues to finance water projects are increasingly difficult to get approved. Congress needs to enact the same ITC and AD for water projects as for solar projects to enable financings throughout the U.S. Additionally, California and other states can help make financings more feasible by enacting a state level ITC and AD and also by excluding privately owned water facilities from property tax and the equipment and other personal property used in such facilities from sales and use tax.

January 7, 2016

[1] Innovative water related technologies are likely to be implemented sooner in privately financed projects. For example, see http://rroyselaw.com/water-and-the-internet-of-things-2016/

December 3, 2015
By Fred Greguras

Forecasters predict that California could receive record amounts of rain during this winter because of El Nino. Smart water management is important in times of no rain or too much rain so our conservation efforts must continue. The Internet of Things (“IoT”) can help the water supply from the El Nino rains be used more efficiently and with less waste.

I became interested in water and the IoT over a year ago when I had a below surface water leak at home that resulted in a large water bill.[1] Since I live in the Silicon Valley, California, the high tech capital of the world, I thought there should be a better way to track water usage so problems can be identified and solved sooner. I needed a smart water meter, an IoT application, that I could read online, at least on a daily basis, to monitor usage and provide actionable information. Motivating water conservation is more effective when users have a clear and timely picture of how water is used.

What is the Internet of Things?

Smart water meters are a form of IoT, a network of technologies which can monitor the status of physical objects, capture meaningful data, and communicate that data over a wireless network to a software application for analysis on a computer in the cloud. Technologies are capable of monitoring objects such as smart water meters and other electronic devices, organisms or a natural part of the environment such as an area of ground to be measured for moisture or chemical content. A smart device is associated with each object which provides the connectivity and a unique digital identity for identifying, tracking and communicating with the object. A sensor within or attached to the device is connected to the Internet by a local area connection (such as RFID, NFC or BTLE) and can also have wide area connectivity. Typically, each data transmission from a device is small in size but the number of transmissions can be frequent.

Each sensor will monitor a specific condition or set of conditions such as vibration, motion, temperature, pressure or water quality. More applications have become feasible because the cost and size of such devices continues to decrease and their sophistication for measuring conditions keeps increasing. Cisco estimates that 50 billion devices will be connected to the Internet by 2020. [2]

For example, at home I would need a smart water meter (device) that collects usage data which is communicated wirelessly to the water utility company where software analyzes the data and reports the results on the web site for me to view. In the San Francisco pilot program described below, a customer can view the data as it comes in, as well as compare their numbers with past use and city averages. The usage data should eventually alert me to a leak or another device that measures water pressure could detect a leak faster. To find the location for repair, however, I would need to add sensors to measure pressure at various locations in my water system. The sensors would be connected to data analytics software in the cloud that would analyze the data transmitted to identify the location of the leak between two sensing points in my water system. This is a much more complex application than simply tracking water usage and illustrates the importance of the software data analysis applications needed in order to make sense of the transmitted data.

Smart Water Meters Status

One of the largest pilot programs of smart meters and related water management software platforms (a smart water management network) is in San Francisco. Water consumption is measured hourly and data is transmitted on a wireless basis to the utility four times a day. Both the utility and customers can track use. A pilot program in the East Bay Municipal Water District, which targets mostly single-family homes, provides a daily update of hour-by-hour consumption via a website. Consumers can be alerted, for example, by email or phone call, when water use exceeds a specified limit or when a meter indicates continuous running water for 24 hours.[3]

At the end of 2014, about 10 percent of California customers were equipped with smart water meters. That number is currently about 15%. While more cities and water districts in California have begun, or are planning, pilot programs, smart water meter implementation remains slow in California and elsewhere around the U.S. Smart water meters in the U.S. account for less than 20% of the approximately 100 million water meters nationwide, according to the smart-utilities research firm IHS Inc.

Budget limitations are the largest obstacle to faster adoption of smart water meters. Smart water meters are more expensive and less ruggedized than traditional mechanical meters. A complete smart meter management network can also be expensive and some utilities do not have the capability to effectively deploy and manage such technology. Some vendors are offering a managed services business model to utility companies for this purpose.

There are more meter and platform products available in the market but there does not appear to be any market leader yet. The products vary from the very basic to those that integrate water metering networks with leak detection and usage monitoring applications.

Can the IoT Help Solve the California Water Problem?

I believe that even the simplest form of smart water meter installed at homes and businesses on a wide spread basis can provide actionable information, which if applied with common sense, can help save millions of gallons of water. [4] If the water utilities can provide the smart meter and basic water management platform, private vendors can offer more sophisticated features that are accessible as an app on a mobile phone similar to how AT&T provides the Digital Life home security system. Private vendors are already offering advanced features such as water leak detection.

The universe of water IoT networks can be divided into infrastructure, governmental, business and consumer. The water infrastructure IoT will help improve a utility’s water quality, supply, treatment, transportation and storage facilities such as reservoirs. Water savings will be the greatest and action should be the fastest at the infrastructure level. A utility should be able to justify the expenditure on the water savings particularly on the basis of planning for scarcity. State and local governments can save money and also have a major impact on supply by implementing the IoT for buildings and other uses like landscape irrigation. An IoT water management network for a large building or office park can help water be used more efficiently. Water cost savings and forced conservation will help drive adoption by businesses (including California’s important agricultural industry) and consumers, but they will be looking for a clear return on investment.

A utility can use an IoT network to remotely determine the status and working condition of equipment (open or closed, on or off, full or empty, etc.). The information can be actionable. A gate can be opened or closed or a pump turned on or off remotely to adjust the flow of water through a water transportation system. Pumps, gates and other equipment with moving parts in the water infrastructure can be monitored for vibration and other indications of failure. If a water pump is about to fail, the utility can be prompted to repair or replace it. An IoT-enabled water treatment plant can report if its filters are clean and functioning properly. The IoT can measure water pressure in pipes to find leaks faster in the water transportation system or the presence of certain chemicals in the water supply.

Agriculture consumes about 40% of the freshwater available in California with a large amount being wasted by leaky irrigation systems, inefficient field application methods and the planting of water intensive crops in the wrong growing location. The IoT has great potential to make water use smarter for the agricultural industry, particularly in irrigation efficiency.

Another focus for water savings should be landscape irrigation in parks, medians and elsewhere. This is a major use of water in cities. Nationwide, it is estimated to be nearly one-third of all residential water use and as much as half of this water is wasted due to runoff, evaporation or wind. [5] Landscape irrigation systems, which apply sophisticated data analytics to a wide variety of objects, are available in the market. [6] Current weather data is combined with sensors for moisture, heat and other data such as the slope of the land, type of soil and the relative exposure to sunshine at a particular time.

Legal Issues

The way that IoT physical components are combined into a network and the related data analytics software can have significant business value. Intellectual property (IP) protection is important. IoT system designers need to think both offensively and defensively in creating an IP strategy so they have the freedom to operate without a license from a third party and also provide a barrier to entry by a competitor. There are already more than 300 patents issued in which the term “Internet of Things” appears when the US Patent and Trademark Office (USPTO) data base is searched.

Ownership rights to data have emerged as an important issue as IoT business models have evolved. The revenue stream potential of such data may be greater than from selling or licensing the software and hardware components of such networks.

IoT networks need to be designed and implemented with adequate security and privacy protection. The threat to security and privacy may not be recognized to be as significant as in other types of networks since IoT devices have limited functionality and connectivity. [7] But there are more points of possible intrusion and vulnerability in an IoT network. A network failure or hacker attack could have serious consequences, particularly in the water infrastructure. For example, a hacker could target sensors at a water treatment facility to cause false readings on whether water is potable. Most water infrastructure IoT networks will have only security concerns but there will also be some privacy issues. Consumer IoT networks will need to protect both privacy and security. Hacking into a smart water meter, for example, could reveal whether or not a family is at home.

As the implementation of smart meter and other IoT networks grows, the data produced can provide actionable information for regulatory authorities for determining compliance by residential, agricultural and other business water users as well as by parties in the water infrastructure. The data can be the basis for enforcement actions so it must be reliable.

There will be liability issues if the IoT network fails or makes a wrong determination. Liability insurance will be needed by the IoT components and systems vendors that provide the network. Limiting liability by contract with a utility, state or local government or business may be feasible in the same way as for other equipment and software but contracts will not be possible in many consumer applications.

Summary

The simplest implementation of smart water meters for residential customers would help conserve millions of gallons of water. The IoT can be used to determine when and how much water is needed in landscape and agricultural irrigation in times of El Nino as well as draught. Although the IoT cannot make it rain or snow or fix leaky water pipes, it can reduce water shortages by providing actionable information to help usage be more efficient and less wasteful.

[1] See Water and the Internet of Things, October 28, 2014, rroyselaw.com/water-and-the-inter-of-things

[2] www.cisco.com/web/solutions/trends/iot/overview.html

[3] Water Meters Begin to Get Smarter, www.wsj.com/articles/water-meters-begin-to-get-smarter-1430881505

[4] 7 Ways Smart Meters Save Water, www.wateronline.com/doc/ways-smart-meters-save-water-0001

[5] www.epa.gov/WaterSense/pubs/outdoor.html

[6] www.govtech.com/fs/perspectives/3-Ways-the-Internet-of-Things-Can-Address-the-Water-Crisis.html

[7] A hacking incident involving connected cars has been mentioned as a warning on the vulnerability of the IoT. www.forbes.com/sites/dougnewcomb/2015/08/10/putting-the-recent-wave-of-car-hack-hysteria-in-perspective/

 

October 28, 2014
By Fred Greguras

I recently became good friends with my water meter once I found it and cleaned the dirt off its face. This friendship was prompted by a water leak that made my bill go through the roof. There was no surface indication of the leak. I don’t pry the lid off the concrete container and manually check the water meter on a regular basis. Do you? Someone from the water company has to do that on a monthly basis to read the meter to determine my bill.

Since I live in the Silicon Valley in California and given our extended drought, I thought surely there is a better way to track water usage so we can identify problems sooner and conserve water as required. I needed an Internet of Things (IoT) application, a smart water meter that I can read online on the utility’s web site. I learned there is a pilot program of smart meters and related technology that recently rolled out in San Francisco. Water consumption is measured hourly and data is transmitted on a wireless basis to the utility four times a day. Both the utility and customers can track use. Currently, however, less than 10 percent of California customers are equipped with such smart devices. Sacramento and other cities are also beginning to introduce such devices but implementation is slow.

What is the Internet of Things?

The IoT is a system of technologies which can monitor the status of physical objects, capture meaningful data, and communicate that data over a wireless network to a software application for analysis on a computer in the cloud. Objects can be electronic devices such as a water meter, organisms or a natural part of the environment such as an area of ground to be measured for moisture or chemical content. A smart device is associated with each object which provides the connectivity and a unique digital identity for identifying, tracking and communicating with the object. A sensor within or attached to the device is connected to the Internet by a local area connection (such as RFID, NFC or BTLE) and can also have wide area connectivity. Typically, each data transmission from a device is small in size but the number of transmissions can be frequent.

Each sensor will monitor a specific condition or set of conditions such as vibration, motion, temperature, pressure or water quality. More applications have become feasible because the cost and size of such devices continue to decrease and their sophistication for measuring conditions keeps increasing. Cisco predicts that 25 billion devices will be connected in the IoT by 2015, and 50 billion by 2020.

For example, at home I would need a smart water meter (device) that generates data about usage which is communicated wirelessly to the utility for the software on its computer to analyze the data and report results on the web site for me to view. In the SF pilot program, a customer can view the data as it comes in, as well as compare their numbers with past use and city averages. The usage numbers should eventually alert me to a leak but water pressure could also be measured with another device which could identify a leak immediately, rather than letting water leak and be wasted until unusually high usage is clear. To find the location for repair, however, I would need to add sensors to measure pressure at various locations in my water system. The sensors would be connected to data analytics software in the cloud that would analyze the data transmitted in order to identify the location of the leak between two sensing points in my water system. This is a much more complex application than simply tracking water usage and illustrates the importance of the software applications needed in order to make sense of the transmitted data.

Can the IoT Help Solve the California Water Problem?

The IoT can’t make it rain or snow or fix leaky pipes but it can help the supply problem by making water usage more efficient and less wasteful, particularly in places where water is scarce. The IoT can also help water be transported to the point of need with greater precision. The universe of water IoT systems can be divided into infrastructure, governmental, business and consumer.

The water infrastructure IoT will help improve a utility’s water quality, supply, treatment, transportation and storage facilities such as reservoirs. The priority for action should be to deploy the IoT at the infrastructure level since the water savings will be the greatest and action should be the fastest. A utility should be able to justify the expenditure on the water savings particularly on the basis of planning for scarcity. State and local governments can save money and also have a major impact on supply by implementing the IoT for buildings and other uses like landscape irrigation. An IoT water management system for a large building or office park can help the manager monitor and manage water use more efficiently. Water cost savings and forced conservation will help drive adoption by businesses (including California’s important agricultural industry) and consumers but they will be looking for a clear return on investment.

A utility can use an IoT system to remotely determine the status and working condition of equipment (open or closed, on or off, full or empty, etc.). A gate can be opened or closed or a pump turned on or off remotely to adjust the flow of water through a water transportation system. Pumps, gates and other equipment with moving parts in the water infrastructure can be monitored for vibration and other indications of failure. If a water pump is about to fail, the utility can be prompted to repair or replace it. An IOT-enabled water treatment plant can report if its filters are clean and functioning properly. The IoT can measure water pressure in pipes to find leaks faster in the water transportation system or the presence of certain chemicals in the water supply and maybe even organic contaminants like the ecoli which was recently discovered in the north San Jose water supply.

Agriculture consumes about 40% of the freshwater available in California with a large amount being wasted by leaky irrigation systems, inefficient field application methods and the planting of water intensive crops in the wrong growing location. The IoT has great potential to make water use smarter for the agricultural industry particularly in irrigation efficiency.

Another focus for water savings should be landscape irrigation in parks, medians and elsewhere. This is a major use of water in cities. Nationwide, it is estimated to be nearly one-third of all residential water use and as much as half of this water is wasted due to runoff, evaporation or wind. An IoT landscape irrigation system is available in the market for public or private use which applies sophisticated data analytics to a wide variety of objects. Current weather data is combined with sensors for moisture and heat and other data such as the slope of the land, type of soil and the relative exposure to sunshine at a particular time.

Legal Issues

IoT systems need to be designed and implemented with adequate security and privacy protection.
The threat to security and privacy may not be recognized to be as significant as in other types of networks since IoT devices have limited functionality and connectivity. But there are more points of possible intrusion and vulnerability in an IoT system. A system failure or hacker attack could have serious consequences, particularly in the water infrastructure. For example, a hacker could target sensors at a water treatment facility to cause false readings on whether water is potable. Most water infrastructure IoT systems will have only security concerns but there will also be some privacy issues. Hacking into a smart water meter, for example, could reveal whether or not a family is at home. Consumer IoT systems will need to protect both privacy and security.

There will be liability issues if the IoT system fails or makes a wrong determination. Liability insurance will be needed by IoT components and systems vendors. Limiting liability by contract with a utility, state or local government or business may be feasible in the same way as for other equipment and software but contracts may not be possible in many consumer applications.

The way that IoT physical components are combined into a system and the related data analytics software can have significant business value. Intellectual property (IP) protection is important. IoT system designers need to think both offensively and defensively in creating an IP strategy so they have the freedom to operate without a license from a third party and also provide a barrier to entry by a competitor. There already several thousand patent applications and over 100 patents issued in which the term “Internet of Things” appears when the US Patent and Trademark Office (USPTO) data base is searched.

Summary

Again, the IoT can’t make it rain or snow or fix leaky water pipes but it can reduce the water supply problem by helping usage be more efficient and less wasteful. We can’t assume the current California water scarcity problem is only temporary. The priority should be to deploy the IoT at the water infrastructure level since savings will be the greatest there. The IoT also has enormous potential to improve the efficiency and reduce waste in agricultural irrigation and landscape irrigation.

 

September, 2014
By Fred Greguras

California Proposition 1, the Water Bond,will be on the November 4, 2014 ballot as The Water Quality, Supply, and Infrastructure Improvement Act of 2014 (the “Act”). Approval by two-thirds of both houses of the legislature and signature by the governor were the first steps. The Act still must be approved by a majority of voters. The Act illustrates the difficulty of public funding of water projects and why more incentives are needed for private sector financing of water projects. Private sector financing can be a simpler, faster and more viable alternative in many cases if the incentives described below are implemented, particularly for smaller projects.

The Act authorizes $7.12B in general obligation(“GO”) bonds for state water supply infrastructure projects, such as drinking water supply and security, water recycling, flood management, ground water sustainability and river, lake, stream and watershed protection and restoration. Water storage is allocated the most funds, about $2.7B. The state commits its “full faith and credit” to repay the GO bonds from general tax revenues. Repayment is projected to require annual payments of about half a billion dollars per year which will have to come from reduced funding for other purposes or from tax increases.

While both the state and local governments may issue GO bonds under the California Constitution (the “Constitution”), state level bonds need be approved only by a majority of voters in an election while local GO bonds must be approved by 2/3 of the voters and are rare. Local governments usually need to increase property taxes to repay the bonds to the extent permitted under Proposition 13. In addition many types of fees have been redefined as special taxes, and such taxes now must be approved by two-thirds of local voters. California voters are unlikely to change the Constitution to make it easier to be taxed.

Voter approval of the Act is not a slam dunk despite the ongoing severe drought in California that threatens drinking water supplies and our agriculture industry.California voters have not passed a water bond since 2006. The Act replaces a previous $11.14B bond proposal which critics labeled as “pork-laden” and was not actually submitted to California voters in either 2010 or 2012 for fear of losing.

The 2/3rds voter approval requirement has made it very difficult for local governmental agencies to raise money for water projects using GO bonds and has caused a greater reliance on state level bonds. The Act, however, will continue to put pressure on local funding because spending under the Act requires matching funds from non-state sources in many cases.

The Act is not enough to solve the California water financing problem. The March, 2014 report, Paying for Water in California, prepared by the Public Policy Institute of California (the “Report”) indicates that, even if the Act passes, funding will, best case, cover half of the total spending gap.

The Public-Private Solution

Fixing the water quality, supply and infrastructure in the U.S. is equally as important as reducing the demand for natural resources in energy generation. Instead of proposing more income and property taxes and fees for public funding of water projects it is time to promote and enable more private sector investment by providing financing incentives to encourage public-private partnerships such as was done for the renewable energy industry. The incentives have worked nationally and in many states to drive the construction of renewable energy generation facilities. Clarification of legal authority may be needed in some states because of prohibitions on non-regulated entities performing governmental functions reserved for regulated agencies. Necessity may drive the authorization of new financing techniques since GO or revenue bond issues to finance new or upgraded water facilities may simply not be feasible.

Water scarcity is not yet a national issue but aging water infrastructure is a widespread problem. The U.S. is in one of the worst droughts in recent history. Over 30% of the country is currently experiencing at least moderate drought measured by substantial crop and pasture losses and water shortages. About 75% of all land area in California is currently under extreme drought with reservoirs at low levels and restrictions on agricultural water use have idled many California farmers.

The concern over the shortage of potable water in California has become so great that the state is investing in long-term solutions such as the Carlsbad, California Desalination Project (“Carlsbad Project”) currently under construction to reduce dependence on unpredictable snow packs and rain. The billion dollar project is being financed with over $700M in tax-exempt bonds with the rest of the financing by a private equity investor. The tax-exempt bonds were issued by the California Pollution Control Financing Authority on behalf of the project developer and the San Diego County Water Authority. The revenue stream for repayment to investors is a long term water purchase agreement (“WPA”) similar to a power purchase agreement (“PPA”) in the solar and wind energy sectors. The WPA provides a predictable source of revenue to make the numbers work for investors and provides the San Diego County Water Authority with long term certainty for water costs.

Financing Large Water Projects: WIFIA Program

One part of the solution may be the enactment in June, 2014, of the federal Water Infrastructure Finance and Innovation Act (“WIFIA”) financing program for large water infrastructure projects throughout the U.S. The purpose of WIFIA is to provide credit assistance to such projects that otherwise have difficulty in obtaining financing. WIFIA will provide low-cost loans from the U.S. Treasury for up to 49% of a project’s cost. WIFIA loans are intended to be combined with other financing alternatives to enable public-private partnerships for financing water infrastructure. Projects must have a revenue stream and demonstrate creditworthiness to be eligible. This requirement should reduce the federal government’s risk and also encourage private investment. Projects which are financed in part by tax exempt bonds, however, such as the Carlsbad Project are not eligible for WIFIA loans. This seems short sighted since the interest cost is lower for tax exempt bonds and a private investor is likely to want to spread the financing risk of the cost of such a large project.

According to a July, 2014 Congressional Research Service report, WIFIA is an important financing tool for large and costly projects but the majority of water infrastructure needs are for smaller projects. The Report indicates that the largest amount of funding for water projects is at the local level and not from state or federal funding.

Financing Smaller Water Projects

National level incentives such as a 30% investment tax credit (“ITC”) and 5 year accelerated depreciation (“AD”) (rather than the current 25 year depreciation) like those that spurred private investment in energy generation are needed to attract private investment to smaller water projects. California can help solve its water problem by authorizing such incentives at the state level as well. Currently, equipment and other personal property used for water desalination, remediation, reclamation, storage or other water projects are not eligible property under the IRC § 48(a) (3)(A) categories or any other IRC § 46 investment credit category.

A water project must have a meaningful revenue stream (WPA, lease payments, water fees, etc.) and demonstrate creditworthiness in order to be viable. Successful project finance depends on making the ROI numbers work for developers and investors with a high degree of predictability. The numbers must work when matching revenue streams against startup and recurring costs. The greater the ratio of equity to debt, the more likely a financing is feasible and the better the debt financing terms that are likely to be available. The availability of the ITC and AD for water projects could be monetized through tax equity investors as in the renewable energy sector. The 30% ITC is scheduled to be reduced to 10% for renewable energy generation property at the end of 2016 so tax equity investors will need to shift their focus to more viable investments.

Excluding property taxes on a water facility when owned privately and eliminating sales and use taxes on purchases of equipment and other personal property used in the facility would also help make a financing more feasible since it would reduce the amount needed to be financed. There are other ways to reduce project costs such as for equipment, construction, operation and maintenance (“O&M”), taxes and financing costs like interest payments. For example, using “bankable” equipment reduces the cost of O&M; using an engineering and procurement contractor with a strong track record reduces construction costs and using the same financing team for multiple projects reduces transaction costs.

Consider the impact of the federal incentives on the financing of a US$40M water reclamation facility. The project entity monetises the ITC and AD with a tax equity investor. The tax equity investment would be about 40% of the $40M or $16M. Assume the sponsor/developer makes an equity investment of 20% or $8M in order to satisfy investors requirements to have skin in the game. The debt financing amount would be $16M. The amount of the debt financing needed becomes smaller because of the equity investments with a resulting smaller amount of debt service that is more likely to be covered by project revenue streams. A revenue bond financing would have to be for the full $40M because of the forbearance requirements of the tax equity investor.

Conclusion

More public water agencies are considering public-private partnerships for financing water projects. Bond issues to finance projects may not be feasible. Congress can enact the ITC and AD which will enable water projects throughout the U.S. The California legislature can help make financings more feasible by enacting a state level ITC and AD and also excluding privately owned water facilities from property tax and the equipment and other personal property used in such facilities from sales and use tax.

 

July, 2014
By Fred Greguras

Graphene is a one-atom-thick carbon sheet with properties that private sector and university R&D labs around the world are investigating and testing for a wide range of commercial applications. I became interested in the material when I read about its potential applications in water purification and clean up, energy efficiency and in solar energy, particularly building-integrated photovoltaic (PV) solar power. The commercialization of the material has been limited to date because it has not been feasible to manufacture high-quality graphene in large quantities for mass commercial use on a cost-effective basis. While the material was discovered and not invented, graphene can be applied in many inventive ways. There are almost 3000 issued patents and just under 9000 patent applications in which the word “graphene” appears when the USPTO data base is searched. Samsung appears to be the early leader in the number of patent applications.

There are many possible applications of graphene still being studied in R&D labs around the globe. Following are a few of them. Graphene’s properties of low weight and great strength could eventually result in the manufacture of light weight components for vehicles and planes. The resulting lighter weight vehicles and aircraft would be more fuel efficient and electric vehicles would have greater range without sacrificing safety. In addition, graphene’s properties will result in batteries for EVs, mobile devices and other purposes that will last longer and recharge faster. Current research indicates the time needed to recharge a battery with a graphene anode is much shorter than with conventional lithium-ion batteries. The disposal of a graphene battery would not have any environmental issues.

A graphene water-filtering system could desalinate sea water at a lower cost than current reverse osmosis techniques without any toxic residual. Graphene filtering systems may also be used for ground water cleanup in places like California’s Central Valley. Graphene with nanometer-sized holes can be an extremely precise water filter with a fast water flow. It can distinguish between different molecules with a high degree of precision, filtering some and letting others pass through. The membranes used in reverse osmosis to filter the salt from the water are thick and require extremely high pressure and energy to force water through them. These membranes are about a thousand times thicker than graphene. A graphene system could operate with much lower pressure and energy requirements and therefore purify water at lower cost. For example, the desalination plant being built in Carlsbad, California is extremely expensive and has a toxic waste residual. The billion dollars’ cost per 100,000 households isn’t a good economic formula for the future.

Lower-cost graphene solar cells could replace silicon PV cells to generate electricity. Graphene reflects less light and absorbs more light which produces electricity more efficiently. Greater efficiency means a smaller surface of graphene could generate the same amount of electricity as a larger silicon surface. The development of a graphene solar cell could eliminate the need for higher-cost materials and the complicated manufacturing techniques needed for today’s PV solar cells. Graphene is effective at absorbing sunlight even when deployed in a thin layer. Presently, it is only possible to use building-integrated PV (solar panels integrated into building materials) for new building construction because retrofitting existing buildings is usually not cost effective. Ultra-thin sheets of graphene could ultimately be used to “wrap” any building so it can generate its own electricity.

None of these technologies are bankable yet but should be closely monitored and a patent strategy considered in a range of technology sectors. Some of these developments could be game changing resulting in product features that are faster, cheaper and better performing which transform entire industries and leave behind those with old technologies.

 

April, 2014
By Fred Greguras

More utilities and municipalities around the United States are considering public-private partnerships for financing the capital expenditures for the upgrade of the aging drinking water and waste water infrastructure. Bond issues to finance the capital expenditures may not be feasible.   There are several basic financing models in which the private party developer and its investors make the upfront capital expenditures needed for the water facility. The utility or municipality then purchases water from the facility or leases it on a long term basis as an operating expense. The Carlsbad, California Desalination Project currently under construction is an example of a long term water purchase agreement (WPA) similar to a power purchase agreement (PPA) in the solar and wind energy sectors.  This project will be the Western Hemisphere’s largest sea water desalination plant. The WPA provides a predictable source of revenue to make the numbers work for investors and provides the San Diego County Water Authority with long term certainty for water costs for planning purposes.

The utility or municipality continues to bill their customers which is the source of their funding for making lease payments or water purchases. The creditworthiness of the utility and predictability of WPA or lease revenues can make the project financeable and provide the return on investment (ROI) for the developer and private investors. Customer rates are usually set by a public utility commission such as the California Public Utilities Commission and are not always related to the real cost of water services. The numbers need to work for the developer and investors and sometimes the customer rates may not generate enough revenue for a project finance to work.

In some cases, the leases or WPAs have a provision permitting the governmental authority to terminate the agreement if there is no annual appropriation for operating expenses for the payments. This results from legal restrictions on the length of contractual obligations unless they are pursuant to a long term bond authorization that has been approved as required by law. There are certain protections that can be added to a WPA or lease to mitigate this risk but, as a practical matter, given the essential governmental purpose of the water facility and the lack of alternatives, investors may take the risk because the probability of termination is remote.

As the number of these financings grow, other utilities may become more comfortable in using innovative financing models.  As has been the case for PPAs in some states, clarification of legal authority may be needed before such models may be used because of prohibitions on non-regulated entities performing an essential governmental purpose reserved for regulated utilities. Necessity may drive the utilities to secure the authority to use the financing technique since bond issues to finance capital expenditures for new or upgraded facilities may simply not be feasible.

The development in the university and private sectors of water-related technology for desalination and potable, waste and ground water treatment is continuing and receiving more attention from investors. For example, a process is available for effluent free desalination which separates the salt as a solid to be sold rather being an environmental risk by going back into the ocean.  Purification technology can clean waste water to a higher degree than ever before, making it fit for human consumption in some cases. The technology used in a project finance, however, needs to be “bankable” rather than at the leading edge in order to provide investors with a high degree of predictability of the facilities performance and receiving payments.

Some of the utility scale water infrastructure projects require hundreds of millions of dollars in funding particularly in large urban areas.  The project costs for smaller water districts can be much less.  The Carlsbad desalination project is projected to cost $1B including water pipeline costs.  The numbers will determine if is possible to apply project finance models to smaller decentralized water facilities as in the distributed model in solar project finance. If a single project is not financeable, financing may be possible for portfolios of smaller water projects in order to have economies of scale.

There is greater potential for the financing of capital expenditures for water projects by private investors but such financings will remain difficult for private investors because of the size and cost of such projects, the cost and time needed for water pipe line and aqueduct improvements, the dollar amount of available revenue streams, site control and technology risks. Successful project finance depends on making the return on investment numbers work for developers and investors with a high degree of predictability.