Explaining cognitive dissonance in Chicago
Published October 5th, 2017
WEFTEC was a bit of a surprise this year. Pretty much everyone I met was feeling upbeat, despite what I reported last week about the US Census Bureau’s Value of Construction Put in Place (VIP) survey showing that water capex was down 23% and wastewater/waste capex down 26% over the past two years.
There are a number of different explanations as to why the mood at the show might be in such sharp contrast to the official data. The first one is that having been brought up in a world of English understatement, I may not be very good at translating the relentlessly upbeat dialect of the American C-Suite. That said, I think that if the market really were that bad, attendees and exhibit shape would be down rather than up.
The second explanation might be that the VIP data does not map directly to the municipal water and wastewater sector as represented by WEFTEC attendees. For example, the VIP data folds solid waste into sewer spend, and furthermore, the timing of a small number of very large federal government projects (e.g. rebuilding the levees around New Orleans) may skew the data. My hunch is that this has some effect, but it cannot explain the scale of the downturn that the VIP data implies.
Another possibility is that it is a timing issue: the Construction Put In Place survey measures spending at the far end of the cycle. The engineers and equipment suppliers I spoke to in Chicago are more interested in current additions to their backlog. This might mean that the VIP survey will start reflecting current industry sentiment in a year or so, when current contracts turn into poured concrete. This is probably true, but I need to do more analysis before I can judge the extent to which it is a factor.
The other possibility is that I only spoke to the winners in today’s market. This, I think, is the most compelling explanation of the dissonance between the VIP data and the straw poll feedback about the state of the market that I picked up at the show. My hypothesis is that the US water and wastewater sector is becoming a three-speed market, with small rural utilities struggling the most, followed by the 500 or so mid-cap cities, while the 30 largest and most dynamic cities – the equivalent of the large-cap members of the Dow Jones Industrial Average – are moving into a class of their own.
The people I speak to – GE Water (now renamed Suez Water Technologies & Solutions), Xylem, CH2M, Veolia, and Stantec – probably make most of their money from the large-cap cities. These cities are actually doing extremely well at the moment in water terms. Even cities like Chicago which are supposed to be on the verge of bankruptcy are actually doing some great things in terms of their water infrastructure investment. They have direct access to the capital markets. They have the scale and the resources which enable them to plan for the future, meet regulatory objectives, and bring their ratepayers along with them. They represent about 12% of the US population, but probably account for more like 25% of the water spend, and that spend is disproportionately focused on higher technology systems and advanced engineering. When this sector thrives, the big engineers and technology suppliers also thrive.
The mid-cap cities are more of a mixed bunch. Typically the water departments don’t have direct access to the financial markets, and they are more reliant on support from their municipal parents in order to get things done. Many of them, particularly on the east coast, have been postponing investment for many years in the hope that some new Federal scheme will arrive that will shield their ratepayers from the cost of the investment they require. These cities typically have a population of between 30,000 and 200,000, and they represent around 20% of the population, and possibly 30% of the total capex spend. That spend is less sophisticated than the large-cap spend. It is more likely to be focused on basic asset management. Often it will go through smaller regional engineering firms. My guess is that capital spending in this sector has probably been falling by low single-digit percentages. The Pittsburgh Water & Sewer Authority is probably the best example of a struggling utility in this category. The primary challenge for these utilities is their financing model: they need to find a way of increasing their tariffs and increasing their independent access to capital.
The real horror show is in the third tier of micro-cap utilities – the 56,000 utilities with fewer than 30,000 connections each. There, the biggest problem is that many of them don’t even know that they have a problem. Many systems are poorly managed, failing to keep up with regulatory requirements, and highly dependent on federal funding (much of it coming from the Department of Agriculture’s Water & Environmental Programs). These utilities serve around two thirds of the US population, but account for less than half of the total capital investment spend – and it shows. The primary challenge for these micro-cap utilities is their lack of institutional strength, both in terms of their management and their financial model. The only solution I can see is consolidation. There are probably 5,000 rural water systems at least as dangerous as the one in Flint, Michigan, but nobody has heard of them because nobody has died yet. Fortunately there are some good ones out there – like the EJ Water Coop, which is consolidating small systems in Illinois. My guess is that capital spending among these micro-cap utilities could well have fallen by more than 20%, but very little of it goes through the big engineers and technology companies who show up at WEFTEC.
All these ideas are just hypotheses at the moment. Over the next couple of months I will be doing more analysis so we can present a more detailed and accurate picture of what is happening at the WaterData markets seminar which closes off the American Water Summit in Austin in November.