Water utility capex investment heads for high-water mark

The value of water and the importance of maintaining a reliable water system has been receiving much-needed national visibility with the passing of the Infrastructure Investment and Jobs Act. Signed into law on Nov. 15, the legislation includes $55 billion in water infrastructure investments to address: the elimination of all lead service lines; modernizing water, wastewater and stormwater systems by providing grants and low-cost grants; and funding to address water contaminants.

Prior to the announcement of the President's Plan, managing these public health concerns had already been a focus of accelerated infrastructure programs across the small investor-owned water utility segment. Total capital expenditure is expected to increase 7.6% in 2021 to nearly $3.8 billion for the eight investor-owned water utilities. Capex grew 17% year over year to $3.4 billion in 2020, a year that was a bit of an anomaly as a result of Essential Utilities Inc.'s acquisition of PNG Companies LLC and the inclusion of Connecticut Water Service Inc.'s capex spending as a part of SJW Group.

* Though recent federal legislation is unlikely to provide a direct benefit to investor-owned water utilities, it brings to the forefront of consumers' and elected officials' minds the state of the nation's drinking water infrastructure.

* Water utility capex programs have been steadily increasing over the past decade fueling rate base and earnings growth. This trend is likely to continue as the nation's infrastructure continues to deteriorate and additional environmental contaminants are identified and regulated.

* CapEx spending is more variable year-to-year at the smaller utilities, with budgets that can swing widely based on individual projects. For the larger, multi-state water utilities, management teams have the flexibility to adjust their capital budgets to absorb larger projects, by scaling back on general main replacement capital projects.

Regulatory Research Associates, a group within S&P Global Market Intelligence, has noted that the trend of accelerated capex spending across the electric, natural gas and water utility industries is likely to continue for some time. Projected 2022 capital expenditures for the 47 energy utilities included in the RRA sample of the publicly traded U.S.-based utility universe currently exceed $146 billion, well above 2021's expected $141 billion investment level, and 2020's $130 billion actual level. For additional details on energy capex, refer to: Energy utility capex plans on-track for record-breaking 2021 and 2022.

Noteworthy company-specific capex changes

The investor-owned water utility industry has posted an average five-year compound annual capex growth rate of over 15%. Notable below, individual company growth forecasts span a wide range, as large multi-year projects from smaller companies can meaningfully swing the capital spending outlook from year to year. Project-variability aside, the driver of water utility capital expenditures has been constant for some time — necessary distribution pipe replacement. This has been augmented by acquisitions and subsequent investment in these systems.

American Water Works Co. Inc., which represents 50% of the segment's expected 2021 capex, projects investment spending 10% above its 2020 benchmark. At the recent analyst day, the company increased its five-year capital expenditure forecast and long-term rate base growth rate. American Water now anticipates investing between $28 billion and $32 billion from 2022 to 2031, a $6 billion increase compared to their previous plan. The capital spending increase boosts the company's long-term rate base growth rate to the range of 8% to 9% from the previous guidance of 7% to 8%.

Middlesex Water Co. has experienced a contraction in its 2021 capex forecast associated with scheduling delays for wellfield treatment upgrades in New Jersey. After revisions in August and November, the company now anticipates investing $77 million this year, down from the original forecast of $138 million. Approximately $38 million of this capex is deferred and expected to be invested in the next 12 to 18 months.

The water utility sector has been on the brink of a massive capital spending undertaking for decades. Widely cited estimates of the investment required to upgrade, replace and expand water and wastewater infrastructure over the next 20 years range from $385 billion to $1.3 trillion.

Favorable national trends encourage additional attention on water investment

The water utility sector's largest investment has been, and continues to be, upgrading the nation's aging distribution systems. Utility regulators largely understand the high level of investment needed to replace aging infrastructure and have supported water and wastewater utility capex budgets at levels significantly above annual depreciation.

Increased regulation by the U.S. Environmental Protection Agency could drive further expansion of water utility capital spending programs. Municipal systems overwhelmed by increased water testing and treatment requirements may look to sell their water and wastewater systems, providing an acquisition opportunity for the investor-owned utilities. Continued expansion of water utilities' operational footprints and capital expenditure programs are likely to support further earnings growth.

Regulatory Research Associates is a group within S&P Global Market Intelligence.