US water infrastructure: Making funding count

The need for investment in the US water system is at an unprecedented level. On average, 14 to 18 percent of total daily treated potable water in the United States is lost through leaks, with some water systems reporting water-loss rates exceeding 60 percent.1“Water efficiency for water suppliers,” US Environmental Protection Agency, accessed September 24, 2021, epa.gov; Harriet Festing et al., “The case for fixing the leaks: Protecting people and saving water while supporting economic growth in the Great Lakes region,” Center for Neighborhood Technology (CNT), 2013, cnt.org. Much of the nation’s water and wastewater infrastructure was built in the 1970s and 1980s. Since then, the share of federal capital investment has declined, putting the majority of capital-funding responsibility on state and local governments, which are increasingly juggling funding priorities.

Systems need to replace aging infrastructure to continue to provide safe and reliable service, but they are also grappling with newer problems, such as emerging water-safety challenges and the need to prepare for climate resiliency, address water scarcity, and deploy new technology to provide effective and affordable service. Fortunately, both public and private funds are available for these investments, and an exciting set of emerging and applied technologies is making it possible to achieve water objectives more efficiently. However, to capitalize on this opportunity, utilities, governments, and private investors will have to prepare thoroughly for the influx of capital.

The average US water-network pipe is 45 years old, with some cast-iron pipes more than a century old.2“Wastewater,” The American Society of Civil Engineers (ASCE) 2021 Infrastructure Report Card, 2021, infrastructurereportcard.org. The Midwest and Southeast have seen particularly high rates of breakage in recent years. The aging infrastructure has also led to high water-loss rates from leaks in the water distribution network system. The US Environmental Protection Agency (EPA) projects water-pipe replacement rates will peak in 2035 at 16,000 to 20,000 miles of pipes replaced per year—four times the current annual replacement rate of 4,000 to 5,000 miles.3“Condition assessment for drinking water transmission and distribution mains,” US Environmental Protection Agency, 2009, nepis.epa.gov. The EPA also estimates that it could take an investment of up to $839 million per year to replace and monitor the 9.7 million to 12.8 million lead service lines that are currently in use in the United States as a response to the updated Lead and Copper Rule.4“National primary drinking water regulations: Lead and Copper Rule revisions,” US Environmental Protection Agency, December 2020, epa.gov; “Lead pipes are widespread and used in every state,” National Resources Defense Council, accessed September 24, 2021, nrdc.org.

Beyond the need to address the aging infrastructure backlog, several challenges add urgency to the need for investment and action:

Regulatory requirements for utilities continue to increase due to rising enforcement of long-standing requirements and the creation of new requirements. The EPA announced two actions in February 2021 to address levels of polyfluoroalkyl substances (PFAS)—a family of human-made chemicals used throughout industry and consumer products—in drinking water (Exhibit 1).5“EPA takes action to address PFAS in drinking water,” US Environmental Protection Agency, February 22, 2021, epa.gov. Studies indicate that PFAS can have serious health effects in laboratory animals.6“Other PFAS research,” US Environmental Protection Agency, accessed September 24, 2021, epa.gov. In December 2020, the EPA finalized its revised Lead and Copper Rule.7“Drinking water requirements for states and public water systems: Lead and Copper Rule,” US Environmental Protection Agency, accessed September 24, 2021, epa.gov. Additionally, dozens of municipalities are executing long-running programs to address combined-sewer overflows following noncompliance with requirements of the Clean Water Act.8“National pollutant discharge elimination system (NPDES): Stormwater discharge from municipal sources,” US Environmental Protection Agency (EPA), accessed September 24, 2021, epa.gov; “Civil cases and settlements by statute,” EPA, accessed September 24, 2021, cfpub.epa.gov. And wastewater-discharge regulations for phosphorus and nitrogen are continuing to tighten in the United States as regional and state regulators ramp up efforts to tackle nutrient-induced algae blooms in waterways. Regulatory requirements may lead to increased capital-investment needs for utilities; for example, McKinsey analysis suggests that new PFAS requirements could lead to a threefold increase in PFAS-related annual capital spending between 2021 and 2025.

As a result of the increase in frequency and intensity of extreme weather events such as droughts and floods, climate resilience is now a top priority for many US governments and water operators. For example, the February 2021 cold wave in Texas9Jack Healy, Richard Fausset, and James Dobbins, “Cracked pipes, frozen wells, offline treatment plants: A Texan water crisis,” New York Times, February 18, 2021, nytimes.com. affected more than 800 local public water systems and caused severe damage to water pipes, with millions of gallons of treated potable water lost through leaks in the system.10Kevin Clark, “Austin’s water pipes leaked hundreds of millions of gallons this week,” KXAN, February 18, 2021, kxan.com.

Federal legislation enacted in 2018 requires community drinking-water systems serving more than 3,300 people to develop or update risk assessments and emergency-response plans by 2021.11“America’s Water Infrastructure Act: Risk assessments and emergency response plans,” US Environmental Protection Agency, accessed September 24, 2021, epa.gov. And water-utility spending on flood management and containment strategies and on alternative water supplies in drought-prone states such as California and Texas is expected to increase; the Infrastructure Investment and Jobs Act includes significantly higher investment in desalination, water conservation, and water recycling.

US water utilities, especially smaller ones, have been slow to invest in technology to improve health, safety, and efficiency. To date, the industry’s investors have focused on opportunistic upgrades—primarily to support data collection and visualization via geographic information systems, smart-meter installation, and upgrades to supervisory control and data-acquisition systems—rather than on full network optimization. Furthermore, the relative immaturity of current digital solutions designed for water utilities has led some early adopters to become frustrated by programs that do not meet performance-improvement expectations. Common challenges of water-utility tech rollouts span both the technical (for example, data scarcity limiting the digital solution’s effectiveness or a mismatch between the solution offered and the utility’s priorities) and the operational (such as a lack of proper labor-force training and staff resistance).12“New report shows U.S. water utilities sector still in early stages of digital transformation,” Dodge Data & Analytics, March 18, 2021, construction.com; Will Sarni et al., Digital water: Industry leaders chart the transformation journey, International Water Association, June 11, 2019, iwa-network.org; “Accelerating the digital water utility,” Global Water Intelligence, November 2019, globalwaterintel-info.com.

In February 2021, hackers targeted the Florida town of Oldsmar’s water-treatment plant, took control of operations, and dangerously increased sodium hydroxide levels in the water.13Andy Greenberg, “A hacker tried to poison a Florida city’s water supply, officials say,” Wired, February 8, 2021, wired.com. This incident reflects a broader trend of ransomware and other attacks on critical infrastructure across sectors and highlights the need for investments in cybersecurity protection for existing—and future—digital assets.

On average, despite growing at 5 percent annually over the past ten years, water rates are lower in the United States than in peer countries in the European Union and United Kingdom (Exhibit 2).

This lag in rates, coupled with growing need in water and wastewater networks, contributed to a combined capital-funding gap of approximately $40 billion in 2020. According to the American Water Works Association’s State of the water industry report, 31 percent of utilities surveyed in 2019 expressed doubt in their ability to cover the full cost of providing services, a figure that rose to 42 percent during the 2020 COVID-19 lockdown.14State of the water industry, American Water Works Association, 2021, awwa.org.

Simply raising rates is not a practical solution because water bills are already too high for many US households. Even before the COVID-19 pandemic, 20.0 percent of US households in 2019 were paying more than 4.5 percent of their household income on water bills—a level that is considered unaffordable. This figure rose to 24 percent in the first seven months of 2021 (Exhibit 3).15Current Population Survey database, Integrated Public Use Microdata Series (IPUMS), accessed August 26, 2021; GWI tariff survey 2021, Global Water Intelligence, 2021, globalwaterintel.com; “U.S. municipal water & wastewater utility rate index, 2021,” Bluefield Research, August 20, 2021, bluefieldresearch.com (assumes average household water consumption of 7,230 gallons per month).

In 2020, 60 percent of utilities surveyed said they experienced or anticipated negative financial impacts during the pandemic due to revenue loss, water-shutoff moratorium policies, and forgiveness of nonpayment bills. Even so, 22 percent of utilities said they expect to defer rate increases to 2022.

The need for federal investment in water and wastewater infrastructure is widely recognized, and efforts to address it are gaining momentum. The Drinking Water and Wastewater Infrastructure Act of 2021 includes $55 billion in funding for the restoration and improvement of water and wastewater systems in the United States.16H.R.3684 - Infrastructure Investment and Jobs Act: “S.914 - Drinking Water and Wastewater Infrastructure Act of 2021,” [Enrolled Bill access date: 11/08/2021]. Clean and safe potable water is a main priority, with $15 billion in funding17H.R.3684 - Infrastructure Investment and Jobs Act: “State and Tribal Assistance Grants (3)” [Enrolled Bill access date: 11/08/2021]. dedicated to the identification, replacement, and monitoring of lead service lines and $4 billion in funding specifically targeting PFAS in drinking water.18H.R.3684 - Infrastructure Investment and Jobs Act: “State and Tribal Assistance Grants (5)” [Enrolled Bill access date: 11/08/2021].

However, even a large increase in federal funding won’t fully cover the needed investment; private capital will also be needed (Exhibit 4).

Investor and private-sector interest in water and wastewater services—both traditional and tech-enabled—is increasing. After largely flat growth in overall M&A transactions in the water sector from 2012 to 2017 (2 percent per year), growth has jumped to 16 percent annually. Activity led by private-equity and infrastructure funds has increased even more rapidly at 26 percent annually over the same period (Exhibit 5). Both private equity and infrastructure funds have also begun to dramatically increase their involvement in the space. While overall transactions have been spread across services, digital, and utility acquisitions, fund-led transactions have primarily focused on services and utilities, given the stable cash flows and opportunity for investments associated with environmental, social, and governance (ESG) objectives.

Increased funding is a necessary component of addressing system issues; however, the investment must be directed toward well-executed projects that improve outcomes for the network. Companies across the water and wastewater value chains need to prepare to meet this challenge—especially given the current broad-based inflationary pressures on raw materials and labor.

The funding gap will likely persist without improvements in efficiency and effectiveness in the system (for example, adopting operational best practices in maintenance, integrating a full suite of digital tools, and gaining efficiency from scale and system design). And while funding will help address critical capital needs for safety and resilience, affordability will still be a challenge for many because most federal funding comes in the form of low-interest loans that may need to be repaid. To make the most of the dollars, utilities can consider both capital planning and execution. (For more on other players, see sidebar, “The near-term water landscape for other industry players.”)

Effective capital planning begins with effective asset management—understanding critical assets, assessing their condition, and identifying any upcoming regulatory commitments and requirements. The utility can then prioritize allocating operations and maintenance capital to the highest-risk and most critically needed assets to reduce long-term costs.

Learning from the power sector, some water utilities are applying new techniques in advanced analytics to help understand their assets’ history, health, and criticality to create a data-driven asset-management strategy.19“How to use analytics,” 2021. Contrary to many utilities’ assumptions, a robust data set is not always a necessary precursor to success; even small data sets (for example, asset structural information and history of corrective work orders) can guide a utility to quick wins in areas such as predictive maintenance and asset-criticality classification.

Effective asset management that guides the categorization and prioritization of potential investment projects will also ensure that incoming capital dollars can be spent on the highest-priority portfolio activities. For example, pipe failure is a leading risk in many portfolios that have multiple alternative solutions other than full replacement. Trenchless pipe rehabilitation (including lining) is well established within sewer pipes as a cost-effective alternative to full pipe replacement and is starting to be piloted for potable water pipes as well.

Looking ahead, projects to shore up resilience will also become a priority due to climate change. For example, utilities will increasingly need to add backup generation and battery storage to ensure continued power supply at critical assets such as pumping stations to prevent flooding and ensure clean water supply during severe weather or other grid outages.

Better procurement and vendor contracting are two of the primary short-term levers that can help small capital-expenditure projects make more efficient use of capital. An increasing number of utilities are engaging in preproject scrubs across these parameters, as well as determining the appropriate cost of materials and labor before finalizing the design. Furthermore, leading utilities and contractors have embraced postmortem reviews of completed projects that can yield lessons about cost variances. For example, one utility found in a postmortem review that a costing model to predict project durations was a problem that led to significant budget and schedule overruns. In response, in the run-up to the next project, it adjusted its approach by implementing new checks and balances between the field and construction and engineering teams in the hours-estimation process, which resulted in trickle-down efficiencies across overtime management and procurement and led to improvements in accounting of expense and capital hours.

Better procurement and vendor contracting are two of the primary short-term levers that can help small capital-expenditure projects make more efficient use of capital.

Utilities should also improve project—and eventually program—management capabilities, especially where capital expenditure has been light in recent years. Increased investment likely will mean utilities are able to tackle projects that have long been in the backlog or involve novel designs and scope; notably, this may require additional expertise to fill gaps in project- and program-management capabilities.

In the long term, if increased investment levels hold, utilities may be able to decrease external spending more effectively and regularly by reducing outsourcing and investing in workforce development, talent, and training programs—a particular priority given the aging workforce in utilities.20Joseph W. Kane and Adie Tomer, “Renewing the water workforce: Improving water infrastructure and creating a pipeline to opportunity,” Brookings Institution, June 2018, brookings.edu. In the past, utilities may not have had sufficient demand to insource work consistently (and consequently maintain the required labor in-house), but increased investment may allow utilities to reduce external contractor spending because more consistent, frequent capital projects may sustain an increased labor force.

By continuing to manage operations and maintenance (O&M) budgets effectively, utilities can not only create additional headroom for capital investments without increasing rates but also improve water quality and reliability for customers. Many of the levers mentioned above—including asset management and efficient contractor management—apply to O&M spending. Additionally, utilities are increasingly incorporating digital and analytics into their capital portfolios to improve operational efficiency. For example, some utilities are upgrading existing meter technology to smart advanced metering infrastructure (AMI) systems, which can reduce both operating costs and nonrevenue water losses. Harrodsburg, Kentucky, in partnership with Ferguson Waterworks and Master Meter, took this approach when it replaced 3,000 smart meters.21“Accomplishing more with less,” WaterWorld, March 23, 2021, waterworld.com. The new meters will allow customers to better manage their water footprints while returning valuable data insights to the city’s water planners. Another example is upgrading to smart-sensor technology in treatment operations to mitigate risk and optimize process efficiencies. In Memphis, Tennessee, an abnormality in increased influent pH led the Stiles Wastewater Treatment Facility to pilot new sensors to provide real-time water-quality testing, monitoring, and data visualization.22Kati Bell, Joshua Balentine, and John Abrera, “Digital solutions enhance source control in Memphis,” WaterWorld, September 14, 2020, waterworld.com.

For decades, an influx of investment into the US water and wastewater infrastructure system has been anticipated—but it has remained elusive. As leaders chart the economic recovery from the COVID-19 pandemic, water investors and utilities are ready to spring into action. In the long term, sustained investment will require greater affordability fueled by a new level of O&M productivity and digital and analytics. If players across the system are strategic, efficient, and well coordinated with one another and with the public sector, there is a unique opportunity to prepare the system to be resilient, safe, and affordable for the generations to come.

Aaron Bielenberg is a partner in McKinsey’s Washington, DC, office, where Sarah Brody is an associate partner and Andrea Grass is a consultant; Hugues Lavandier is a senior partner in the Paris office; and Alejandro Paniagua Rojas is a specialist in the Waltham office.

The authors wish to thank Megan Leitch and Drew Vance for their contributions to this article.