Before the war, water pipes were usually over-engineered. That is, they were cast-iron pipes, built to last forever. The average useful life of water pipe from the 1920s is over 100 years. After the war, people had to be stingier in the construction of these pipes. We’re feeling the effects of this today.

More than 56% of all water breaks today occur in pipes built in the 20 years immediately after World War II. Many of those pipes are reaching the end of their useful lives.

I caught up with Thomas Rooney after the holidays. He is the former CEO of Insituform Technologies, a water pipe replacement company. He told me the story above about the World War II metal shortage, which I found fascinating. Rooney’s a good guy with a lot of insight into the water and infrastructure sector. He shared some of those insights in our recent talk.

He noted that just because pipes need replacements doesn’t mean it will happen. In fact, as Rooney explained, there is a subtle link between infrastructure spending and new housing construction. This link suggests that spending on water infrastructure will decelerate, just when obsolescence demands that spending should accelerate.

One of the bubbles that burst over the last eight-nine months, Rooney told me, is the idea that water infrastructure spending is “recession proof.” A water utility is recession proof, Rooney offered. “It’s just like how you’ve got to buy power.” But water infrastructure spending is not.

Consider the mechanism for how water infrastructure funding works. Much of it comes from “tap fees.” When a developer builds a new development, he pays tap fees to the local utility. These tap fees are supposed to cover the cost of connecting that house to the public water system. But in reality, the developer puts in everything. It costs the local utility close to zero to accept these tap fees. Usually, its cost is simply to get an inspector out at the site to approve the work.

Well, this amount of money turns out to be huge. The average tap fee in the U.S. is $1,500-2,000 per home. Consider that we were building two million homes per year. That’s $4 billion in free cash flow for the utilities.

Housing starts, as we know, have collapsed. Take a look at this chart from the U.S. Census Bureau:

So guess what happens to tap fees? Poof! Water infrastructure spending feels the pain of that.

Rooney was one of the first people to point out this connection between infrastructure spending and new housing construction. As Rooney says, infrastructure spending is discretionary.

There is good news, though. As we watch U.S. spending contract, it’s a different story in other parts of the world. In Canada, where the commodities boom helps line government coffers, infrastructure spending is rising in double digits. “Where there is loose change,” Rooney says, “you see discretionary spending go nuts.”

Even then, Canada could spend more. Ontario wastes $1 billion every year in water. But the government says it would cost $11 billion to fix. Thinking like bureaucrats, Ontario officials believe they are making a good decision in “saving” $11 billion every year. But in the private market, you could easily finance $11 billion in return for a promised $1 billion annual return. That’s a 9% cash return.

The ultimate bubble, Rooney says, is the idea that even current spending is recession proof. It isn’t. As Rooney says at Insituform, he saw spending not only slow, but actually contract. So we are in the ironic situation of having worsening infrastructure problems, but a declining level of spending to fix them.

There is still a huge opportunity remaining in the water sector. It starts with a little saying: “It takes a lot of water to make oil, and it takes a lot of oil to make water.” It’s called the energy-water balance, or the energy-water nexus. “People are going to make tremendous amounts of money by focusing on the confluence of water and energy,” Rooney says.

For example, how to extract oil by using less water — that’s a big issue. Also, refining oil requires a lot of water, as does processing and transporting various sources of energy. Utilities use water for cooling and emissions scrubbing. Hydroelectric power, of course, uses water directly. In fact, hydropower accounts for about 40% of all freshwater usage in the U.S. That’s a massive amount of water, behind only irrigated agriculture.

I’ll be sure to continue my research on this subject, no matter where it takes me. I’ll be sure to let you know, whenever I find out more…

Sincerely,

Chris Mayer
March 6, 2008

Water Infrastructure During the Recession was originally featured in the Penny Sleuth.