Financing A Sustainable Water Plan for Texas:Part 3

This is the final installment in the three-part guest blog series from Sharlene Leuring.  We will make all three blogs available as a PDF at www.texascenter.org soon. 

Installment 3: Financing Water Conservation and Efficiency

As the debate over Prop 6 played out, many advocates highlighted the fact that the underlying legislation, HB 4, provides that a certain percentage of funding should be dedicated to water conservation and reuse.  The specific terms are important.  HB 4 creates section 15. 434(b) of the Texas Water Code, as follows (emphasis added):

 (b)AAOf the money disbursed from the fund during the five-year period between the adoption of a state water plan and the adoption of a new plan, the board shall undertake to apply not less than:

 (1)AA10 percent to support projects described by

Section 15.435 that are for:

(A)AArural political subdivisions as defined by

Section 15.992; or

(B)AAagricultural water conservation; and

(2)AA20 percent to support projects described by Section 15.435, including agricultural irrigation projects that are designed for water conservation or reuse.

 Even with this “undertake to apply” goal (which is a minimum, not a maximum, of what can be spent on conservation), there are serious questions about how TWDB can provide financial support for some types of non-agricultural conservation strategies, especially those involving improving assets held by private citizens or businesses outside of the agricultural sector.    This is important because a significant portion of the state’s conservation potential is in reducing the water footprint of homes, industry and businesses, something that often requires replacing inefficient appliances, irrigation systems and industrial equipment with water-efficient technologies.  The central questions are (1) whether these improvements are amenable to the type of “debt-financing” available through the Prop 6 funding and (2) whether there are constitutional or other statutory prohibitions on using state funds for these strategies since they would create a “private benefit.”

Because the TWDB already has a program for agricultural conservation loans, the use of Prop 6 funds through SWIFT for those activities should be more straightforward.  The 2012 State Water Plan projects significant needs for agricultural water conservation.  For example, Region M projects that $ 132 million would be needed to conserve about 140,000 acre-feet/year in agriculture by 2060.  Region O projects a need to invest $ 346 million  in agricultural efficiency measures to save 480,000 acre-feet per year, helping to reduce pressure on the dwindling Ogallala aquifer. Given these needs and the issues with financing customer-side efficiency improvements at the municipal level, it may be that most of the conservation funding through SWIFT goes to agricultural efficiency projects. (It is important to note that agricultural efficiency programs don’t necessarily make more water available for other uses, as farmers often use the water saved to expand crop production. However, there are examples of arrangements in which water efficiency improvements on the farm have yielded water for municipal or environmental uses.)

Nevertheless, municipal conservation is a vital strategy for Texas to balance growth with limited water supply.  The remainder of this post looks at what role, if any, Prop 6 might play to advance this strategy. 

Debt-financing municipal conservation measures

The first question is why municipal water systems would choose to debt-finance water efficiency improvements for their customers?

Water conservation is actually a source of supply, just like a reservoir or a desalination plant. The redefinition of water conservation from a demand tool to a supply source was a major paradigm shift for water providers, but is now commonly understood. Investments in water conservation strategies with a clearly defined yield and lifetime can be debt-financed, and repaid through revenue raised from a water suppliers’ customer payments, just as they would pay back costs for any other water supply investment.

It appears that the only source of municipal water conservation to which the Board has provided financial assistance in the past is the repair of leaky distribution systems—the aging pipes that move water from the source to the customer. The amount of water lost in transport from source to user can be significant. A 2010 survey by the Texas Water Development Board found that, on average nearly 15% of water treated and sent through municipal systems is lost before ever reaching a customer (based on 1,900 systems reporting data)   Small systems serving 10,000 customers or less averaged about 20% total water loss, and large systems with 100,000 customers or more averaged 15%.

Because the replacement of a distribution system is an investment in the water system’s own assets, it is a perfectly acceptable use of debt funds.  Thus, reducing system water loss should be a desirable and authorized use of the SWIFT funds.

However, there are other municipal conservation programs aimed at individual water customers that can provide a reliable source of water supply.  The most reliable of these “customer-side” approaches are those that replace physical systems, such as programs that provide rebates or other incentives for replacement of inefficient toilets or water boilers or for replacement of water-intensive landscaping with water-efficient landscaping.

These types of programs generally are more reliable in terms of supply than those that rely on changes in customer behavior (changes which may or may not be permanent and which are often influenced by perceptions of immediate drought).  

Through a a combination of appliance retrofits and lawn buy-back programs, Las Vegas has saved over 59.3 billion gallons of water since 1999.  The city has spent $200 million to replace more than 150 million square feet of turf lawn over the past decade, with long-term water savings guaranteed by covenants ensuring that homeowners will not reinstall lawn they were paid to remove unless they repay their rebate.  Recently, Austin Water announced it was launching its own lawn buy-back program.

Debt-backed capital investment programs allow water utilities to mobilize far more capital today than cash-backed capital programs. (For more explanation of the debt-financing envisioned by SWIFT, including a glossary of terms, see Installment 1 in this blog series).  The benefit of debt-financing is that water systems can borrow the money for what is needed today, with future repayment backed by a pledge of future customer revenues. In comparison, cash spent today must be available today. Since water systems raise their cash from customer payments, a cash-financed program typically means higher rates today than a debt-backed program. As a result, debt-financed programs allow water systems to smooth the increase in customers’ rates.

Debt cannot be used for behavior change programs—the debt issued for a capital program must be used to finance the construction, acquisition or improvement of capital assets. It cannot be used for operations and maintenance (for example, paying the energy bills for a water treatment plant) or for public outreach programs (for example, media campaigns to educate water users about conservation). These aren’t rules set in Texas, they are rules set by the Governmental Accounting Standards Board, the entity that defines accounting standards for the municipal bond market in which the Texas Water Development Board participates.

But efficiency programs with a defined water yield are an investment in a capital asset—water supply—and should thus qualify for debt financing. And, in fact, there are water systems that use bond proceeds to finance customer efficiency programs. Seattle Public Utilities has used debt funds to finance the retrofitting of toilets and other water-using devices with low-flow replacements.  In Seattle what made this possible was defining the “asset” being financed not as toilets, but as the long-term water savings gained by toilet retrofits.

The potential for water efficiency investments on customers’ property does not end with toilets or turf grass. Institutional irrigation systems, industrial machinery, any physical water distribution or water-using device with a long lifetime can be a source of long-term water savings, and therefore supply. And Texas is uniquely positioned to unlock the water savings in its industrial, commercial and institutional sectors with the passage last session of the Property Assessed Clean Energy Act.  This new law  permits municipalities to use bonds to finance customer loan programs for energy and water conservation purposes, including water conservation systems, high efficiency irrigation equipment, on-site improvements to use municipal reclaimed water, and more.  This type of bond (called a PACE bond) is repaid through tax assessments that remain attached to the property no matter who the future owner may be. The PACE bond concept holds significant potential for funding a transformation in the water intensity of Texas’ economy..

So, if it is desirable to pursue a large-scale customer efficiency program (and if such approaches are included in the state water plan), and if debt financing would make it easier to do that, SWIFT funds would be made available for that purpose, right? Not necessarily.

Public Purpose v. Private Benefit

The ability to use SWIFT funds for these customer-side efficiency improvements largely comes down to whether programs that improve an asset owned by a private citizen or a business can be financed with public monies.

Texas, like most states, has a Constitutional prohibition against the use of public funds for private benefit, something called “the gift clause.”  As discussed in this post by the Energy Center at the University of Texas School of Law, Article III, Sec. 52(a) of the Texas Constitution prohibits the state from lending credit or granting money to “any individual, association or corporation whatsoever,” a prohibition that can be relaxed for activities that would enable a public purpose.  

Defining a public purpose is where the complications begin, however.  In many instances, legislators have opted to explicitly authorize the use of state financing for specific activities rather than leave to the courts what might be reasonably construed to serve a public purpose. Such is the case with toll roads, for which purpose the state’s credit has been authorized in numerous amendments.

In fact, one piece of legislation from the 2013 session attempted to do just that for water conservation. House Joint Resolution 142, filed by Chairman Alan Ritter (the House sponsor of H.B. 4), would have expressly defined water conservation as a public purpose eligible for state funding.  As filed, HJR 142 provided that  “[n]otwithstanding any other provision of this constitution, the legislature may provide for the creation of programs and the making of loans and grants of public money, other than money otherwise dedicated by this constitution to use for a different purpose, for the public purpose of water conservation.”

Unfortunately, H.J.R. 142 did not advance through the legislature, leaving the question of whether the Board or other state agencies can lend their credit for the public purpose of municipal water conservation open to the determination of the Texas Water Development Board and for potential challenge in the courts.

Texas does have some history of using state credit for private benefit that serves a public purpose. One example is the use of TWDB funds to address the lack of safe drinking water and sewage treatment in colonias along the Mexican border. (The following is adapted from email correspondence with former bond counsel to the TWDB.) In the 1990s, the Board deliberated whether the gift clause prohibited it from making financing available for connections of homes water and wastewater utilities. Ultimately, the Board decided that as long as four tests were met, use of public funds would not constitute an unlawful gift or lending of credit. The four tests were:

1.  Does the expenditure serve a public purpose?
2. Are there sufficient controls on the expenditure to ensure that the public purpose will be carried out?
3. Is the public protected in the use of public funds to accomplish the intended result?
4. Has the political subdivision making the expenditure adequately considered this use of funds?

If TWDB defines water conservation as a public purpose in its prioritization and rulemaking processes, and if it ensures sufficient controls over the use of funds to achieve that purpose (such as audits of water savings, installation of water-saving devices and deed restrictions or other assurances for their longevity), the TWDB would likely have sufficient grounds to include customer-side municipal water conservation programs as eligible for SWIFT funds.  Using SWIFT funding for customer-side municipal water efficiency programs could help ramp up this cost-effective water supply strategy in communities across the state.

Effective use of the Prop 6 conservation earmark to include these programs will require a change in practice and perspective and clear rules from the TWDB, (and it will require that such programs be explicitly included as strategies or projects in the state water plan).