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Measuring Financial Capacity and the Effects ofRegulatory Changes on Small Water Systems in NovaScotiaBettina Brown , Alfons Weersink & Rob C. de LoëPublished online: 23 Jan 2013.

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Canadian Water Resources Journal Vol. 30(3): 197–210 (2005) © 2005 Canadian Water Resources AssociationRevue canadienne des ressources hydriques

Bettina Brown1, Alfons Weersink1 and Rob C. de Loë2

1 Department of Agricultural Economics and Business, University of Guelph, Guelph, ON N1G 2W12 Department of Geography, University of Guelph, Guelph, ON N1G 2W1

Submitted January 2005; accepted July 2005. Written comments on this paper will be accepted until March 2006.

Measuring Financial Capacity and the Effects of Regulatory

Changes on Small Water Systems in Nova Scotia

Bettina Brown, Alfons Weersink and Rob C. de Loë

Abstract: Municipal water systems are dealing with increasing regulatory compliance costs, aging infrastructure and declining government support. The hypothesized negative effect on fi nancial capacity is assumed to be greatest for rural water systems that have to meet the same quality standards, but with higher marginal service costs and a lower revenue base. This paper examines whether regulatory changes that occurred in the drinking water industry in Nova Scotia in 1995 had negative repercussions on the fi nancial capacity of four rural water suppliers in the Annapolis Valley. The extent of the impacts varies across the four water systems.

Résumé : Les systèmes d’approvisionnement en eau des municipalités doivent composer avec la hausse des coûts de la conformité aux règlements, le vieillissement de l’infrastructure et la diminution du soutien de l’État. On présume que l’incidence négative hypothétique sur la capacité fi nancière est plus élevée pour les réseaux d’alimentation en eau qui doivent répondre aux mêmes normes de qualité, mais qui font face à des coûts différentiels des services plus élevés ainsi qu’à une base de revenu moindre. La présente communication cherche à déterminer si les modifi cations en matière de règlementation qu’a connues l’industrie de l’eau potable en Nouvelle-Écosse en 1995 ont eu des répercussions négatives sur la capacité fi nancière de quatre fournisseurs d’eau ruraux dans la vallée de l’Annapolis. La portée des incidences varie entre les quatre systèmes d’alimentation en eau.

Introduction

Drinking water suppliers across Canada are dealing with increasing regulatory pressures in the face of aging infrastructure, declining fi nancial support from government, and emerging threats to water supplies. A number of well-profi led water problems, most notably the contamination of the water supplies of the Town of Walkerton, Ontario (in 2000) and the City of North Battleford, Saskatchewan (in 2001), have reinforced

the need for appropriate standards (Christensen and Parfi tt, 2001).

Unfortunately, appropriate standards regarding the treatment, distribution and monitoring of water supplies are not suffi cient to ensure drinking water safety. It is now widely understood that ensuring drinking water safety demands use of a multi-barrier approach, involving protection of the sources of water, as well as proper treatment, distribution and monitoring (Pollution Probe, 2004). Broadening the

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198 Canadian Water Resources Journal/Revue canadienne des ressources hydriques

© 2005 Canadian Water Resources Association

focus of drinking water safety beyond the utility itself adds to the challenges faced by local water suppliers (de Loë et al., 2002). Hence, attention has to be paid to questions of local capacity. Concerns about capacity are particularly important in the case of drinking water systems serving small communities. For example, in the United States, recognition that small systems were struggling to comply with new requirements under the 1986 Safe Drinking Water Act (SDWA) motivated Safe Drinking Water Act (SDWA) motivated Safe Drinking Water Actthe focus on capacity building found in the 1996 amendments to this statute (Cromwell et al., 1992; Shanaghan et al., 1998; Soelter and Miller, 1999).

The capacity of drinking water systems to provide safe water is a multi-faceted phenomenon. Under the 1996 amendments to the SDWA, the capacity of a water supplier to provide safe water is defi ned in terms of technical, managerial and fi nancial dimensions (United States Environmental Protection Agency [US EPA], 1998). Technical capacity is a function of the extent to which utilities are able, in physical and operational terms, to meet SDWA requirements. Managerial capacity is based on the way in which utilities conduct their business affairs. Financial capacity relates to factors such as fi scal management and revenue suffi ciency.

This paper is concerned primarily with fi nancial capacity. Utilities that have insuffi cient fi nancial capacity will struggle to meet regulatory requirements and, ultimately, to provide clean water. For example, they may not be able to acquire the needed technologies or to upgrade aging infrastructure. It has been estimated that an investment of $38 billion is needed to maintain and restore existing water infrastructure in the country (National Round Table on the Environment and Economy, 1996).

Lack of fi nancial capacity has many sources. For instance, water rates that cover only a portion of the marginal costs of water treatment limit the fi nancial resources of municipal systems and constrain the capability to re-invest (Renzetti, 1999). In addition, low rates increase demand and put added stress on treatment and distribution systems (Brubaker, 2002). It has been estimated that under-pricing increases the need for large infrastructure investment by $27.6 billion (Canadian Water and Wastewater Association, 1997). As municipal water systems in Canada struggle to provide suffi cient quality and quantity of water in the midst of increasing regulatory pressures from senior levels of government, the fi nancial support from

these levels of government has declined signifi cantly (Pearse, 1998).

Financial capacity issues facing municipal water systems in Nova Scotia are typical of the ones facing other providers across Canada. Non-compliance was the norm for sewage treatment plants in the province according to Nantel (1996) and led in 1995 to new standards on mandatory operator training and certifi cation and compulsory compliance with water regulations (Nova Scotia Department of Environment and Labour [NSDEL], 2002b). Even though problems related to excessive deterioration of water facilities were blamed on under-funded and inadequate operating budgets, the provincial government had cut spending in water management. The fi nancial pressures appear to be greatest for small, rural water systems, which are commonplace in Nova Scotia. Although forced to maintain the same technology in order to meet the same regulations as larger systems, sparsely populated regions have less access to fi nancial resources compared to larger suppliers.

The purpose of this paper is to determine how the fi nancial capacity of local water systems in Nova Scotia was affected by changes in provincial government water regulations and standards that occurred in 1995. The paper begins by describing the changes in the regulatory regimes facing water suppliers in Nova Scotia. It then describes the methods to assess changes in fi nancial capacity, which is measured in this study by eight fi nancial ratios. Regression analysis is used to estimate whether there have been signifi cant changes in the intercepts and/or trends of eight fi nancial ratios between two periods: before the regulatory changes occurred (pre-1995) and after (post-1995). The following section of the paper describes the four municipal water systems in the Annapolis Valley of Nova Scotia (Middleton, Kentville, Bridgetown and Wolfville) and the data sources used to determine the effects of the regulatory changes. Results and implications are then discussed.

Regulatory Changes Affecting Water Systems in Nova Scotia

In the Province of Nova Scotia, all three levels of government are involved in water management. The federal government regulates navigation, protects fi sh habitats, and provides funding for both provincial and

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Brown, Weersink and de Loë 199


municipal initiatives. Its main impact on public drinking water suppliers is through the Drinking Water Quality Guidelines (Health Canada, 2004), which were originally Guidelines (Health Canada, 2004), which were originally Guidelinescreated in 1968, and have been adopted by Nova Scotia to set acceptable levels of microbiological, chemical and physical, and radiological parameters for water.

The provincial government has the legal authority to manage water resources through its jurisdiction over natural resources and municipal institutions. Under the Environment Act (SNS. 1994-95, c.1), Environment Act (SNS. 1994-95, c.1), Environment Actthe Nova Scotia Department of Environment and Labour (NSDEL) is designated as the lead agency for the management of water quantity and quality issues. With the authority provided by the Water and Wastewater Facility Regulations (N.S. Reg. 60/95), Wastewater Facility Regulations (N.S. Reg. 60/95), Wastewater Facility Regulationsunder the Environment Act, the NSDEL regulates water withdrawals, creates standards on how to monitor water quality, and ensures that water facilities meet classifi cation requirements and that operators have adequate training. The Guidelines for Monitoring Public Drinking Water Supplies provide specifi c procedures for Drinking Water Supplies provide specifi c procedures for Drinking Water Suppliesmonitoring public drinking water supplies with respect to microbiological, chemical and physical parameters, as well as monitoring disinfection residual, fl uoride concentrations and water turbidity (NSDEL, 2000).

Municipal governments in Nova Scotia provide water services to residents, usually by operating municipal water utilities, and by undertaking land use planning and area zoning. Utilities can protect water supplies from activities such as mining, agriculture, forestry, livestock grazing and boating within water supply watersheds. This is accomplished by designating sensitive areas as protected water areas under the Environment Act (SNS 1994-95, c. 1). Municipalities Environment Act (SNS 1994-95, c. 1). Municipalities Environment Actcan also use the Municipal Government Act to establish Municipal Government Act to establish Municipal Government Actprotected water supply areas (Municipal Government Act, 1998, c. 18). According to Timmer (2003), municipalities in the Annapolis Valley had not used these powers as of December 2002.

Several important regulatory changes affecting drinking water systems have occurred in Nova Scotia during the past decade. Most importantly, in 1995 the Water and Wastewater Facility Regulations (N.S. Water and Wastewater Facility Regulations (N.S. Water and Wastewater Facility RegulationsReg. 60/95) required the registration of water supply systems, mandatory operator training and certifi cation, compulsory compliance with water regulations and standards, a requirement for chemically-assisted fi ltration of surface water, and a requirement for regular water testing and reporting. Under this regulation, the

Drinking Water Quality Guidelines became mandatory. Drinking Water Quality Guidelines became mandatory. Drinking Water Quality GuidelinesIn 2000, Guidelines for Monitoring Public Drinking Water Supplies were introduced. The Water Supplies were introduced. The Water Supplies Nova Scotia Drinking Water Strategy (NSDEL, 2002a) requires that Drinking Water Strategy (NSDEL, 2002a) requires that Drinking Water Strategyall surface water systems must have chemically-assisted fi ltration and disinfection in place by 2008. If surface water infi ltrates groundwater aquifers, then the surface water guidelines come into effect for groundwater systems as well and the utility would have to construct a groundwater fi ltration plant.

Measuring the Effect of Regulatory Changes on Financial Capacity

In light of the fi nancial trends affecting local water suppliers discussed in the introduction, it is reasonable to assume that the more stringent regulatory environment established in Nova Scotia in 1995 negatively affected the fi nancial capacity of the utilities. This section explains how fi nancial capacity is defi ned so that this can be tested.

Financial capacity is defi ned here as the ability to meet the fi nancial obligations required for operating and maintaining a water system at or above a level that enables it to meet all government water standards and regulations and to provide clean consumable drinking water to users. This defi nition refl ects the perspective on capacity of the 1996 amendments to the United States Safe Drinking Water Act. From the perspective of a water utility, the US EPA (1998, p. 12) states that fi nancial capacity is “a water system’s ability to acquire and manage suffi cient fi nancial resources to allow the system to achieve and maintain compliance with SDWA requirements”. This includes the ability of the system to obtain adequate fi nancial resources to meet the day-to-day operations of the system, along with future demands on the system, and to undergo any improvements required to meet all regulatory restrictions placed on the system.

Financial capacity can be measured using a variety of criteria. Six of the eight criteria used in this study are part of the “Ratio8” system developed by the Environmental Finance Center at Boise State University (EFC, 2001). These six are Debt Ratio, Current Ratio, Operating Ratio, Sales Ratio, Expense Ratio and Receivables Ratio. Two other criteria, refl ecting ratios developed by Dreese and Beecher (1993) and Jordan et al. (1997) were also used, Profi tability Ratio and Cash

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Flow Coverage Ratio. The desired ranges for each ratio, shown in Table 1, were taken from the sources that provided the criteria. For example, EFC (2001) suggests that a fi nancially healthy utility should have a Sales Ratio close to one, indicating that revenue is coming primarily from usage charges.

The values resulting from the eight fi nancial ratios described above were calculated from available data for each of the four utilities and examined to determine whether they fell within their appropriate value ranges. Each fi nancial measure has 12 observations for each utility studied (see below), representing 12 years that make up the study period (1990-2002). In addition to assessing the fi nancial performance for each ratio in individual years, the following regression was run to determine if there have been changes in the average and/or trends in the ratios over the pre- and post-regulatory periods:

FRi = i = i β0 + β1 Reg + Reg + Reg β2 Trend + Trend + Trend β3 Reg× Trend + Trend + Trend ε (1)

where FRi is the value of fi nancial ratio i is the value of fi nancial ratio i i (i (i i=1,2,...,8), Reg is a dummy variable equal to one for years with Reg is a dummy variable equal to one for years with Regthe regulations in place (after 1995) and zero for prior years, Trend is a time trend variable equal to one for Trend is a time trend variable equal to one for Trendthe year 1990/91 and increasing by one thereafter, εis a normally distributed error term, and the β’s are the estimated parameters. The full model given by Equation (1) was estimated with variables dropped if statistically insignifi cant and the remaining parameters then re-estimated. There are thus four possibilities: 1) a shift in both the intercept and trend due to the regulation along with a signifi cant trend in the fi nancial measure (β1 and β3 signifi cant); 2) a change in

the trend (β3 signifi cant); 3) a change in the intercept with a constant trend over time (β1 and β2 signifi cant); and 4) a change in the mean due to the regulation but no trend (β1 signifi cant). If none of the parameters are signifi cant, then there was no trend or change in the average value of the fi nancial measure between regulatory periods. Financial capacity was considered reduced by the regulations if the trend and/or mean values move away from their desired range (Table 1).

Overview of the Case Study Systems

The Annapolis Valley, located in northern Nova Scotia, is mainly rural, with several towns and villages scattered throughout (Figure 1). Four community water systems within the Annapolis Valley were chosen for this study. These serve the largest towns within the Annapolis and Cornwallis watersheds, Wolfville (pop. 3,658) and Kentville (pop. 5,610), and two of the larger villages, Bridgetown (pop. 1,035) and Middleton (pop. 1,744). Due to serious water quality problems affecting their surface water sources, three of the systems switched to groundwater sources during the study period: Middleton in 1993, Wolfville in 1995 and Kentville in 2001.

The Middleton water utility used two deep groundwater wells as its water source and was in the process of constructing a third well during the study. The utility served roughly 3,500 customers, 57 percent permanent residents and 43 percent transient customers associated with the local schools. There were roughly 850 service connections, 88 percent domestic, ten percent commercial, and two percent institutional. Groundwater was pumped from an aquifer and treated

Table 1. Defi nition and Acceptable Range of the Components of Financial Capacity.

Financial Attribute Financial Ratio Ratio Calculation Desired Range

Solvency Debt Ratio Total Liabilities/Total Assets < 0.4Liquidity Current Ratio Current Assets/Current Liabilities > 1.0Profi tability Profi tability Ratio Cash Flow/Sales > 0.2Debt Coverage Cash Flow Coverage Ratio Cash Flow/Principle and Interest > 1.5Level of Expenditures Operating Ratio Operating Revenue/Operating Expenses > 1.0Revenue Reliance Sales Ratio Usage Charges/Total Revenue > 0.6Capital Investment Availability Expense Ratio Operating Expenses/Total Expenses < 0.4Timeliness of Bill Collection Receivables Ratio Accounts Receivable/Usage Charges < 0.4

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Figure 1. Location of the Annapolis Valley and the four water systems studied.

using chlorine both before and after storage in the reservoir. The utility was able to produce approximately 1000 m3 per day and could store approximately 4,500 m3 in its reservoir. The facility was Class II and had an operator with Class I certifi cation (referring to the system established in Nova Scotia under the 1995 Water and Wastewater Facility Regulations). The service connections to all customers were metered.

The largest town in the Annapolis Valley, Kentville, had one of the largest water systems in the area. The utility had nine deep groundwater wells in production and one more ready in the event of increased demand. The system served approximately 7,600 customers, with approximately 2,700 service connections, 98 percent of which were domestic and two percent industrial. Groundwater was pumped from two aquifers, treated using chlorine, stored in a covered reservoir, and pH adjusted. The facility

was capable of producing approximately 11,300 m3

per day and could store approximately 13,600 m3 of water in its reservoir. The facility was Class II and had an operator with Class II certifi cation. As with Middleton, this utility was 100 percent metered and used a two-part tariff water pricing structure to set water rates for its customers.

The Bridgetown water utility used water from two surface sources, Crosskill and Foster Lakes. The surface water was considered to be of good quality and had low turbidity. The system served approximately 1,400 customers, with approximately 574 service connections (93 percent domestic and seven percent commercial and institutional). Water was moved by gravity fl ow from the lakes to the treatment plant. At the facility the water was treated with chlorine prior to being stored in an open reservoir, with a capacity of approximately 4,500 m3. The facility was capable

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of producing approximately 1,000 m3 per day and was classifi ed as a Class II facility with a Class I operator. The utility used a two-part tariff water pricing structure and all service connections were metered.

Wolfville had the second largest water system in the Annapolis Valley. This utility operated using two groundwater wells, with a third well in the process of being completed during the study. The system served approximately 6,000 customers and had approximately 1,400 service connections, 83 percent domestic, 9.8 percent commercial and 7.2 percent institutional. Its biggest customer, Acadia University, used roughly 30 percent of the water. The facility produced approximately 2,700 m3 per day and could store approximately 13,600 m3 of water in its reservoir. The facility was certifi ed as Class II and the operator had a Class I certifi cation. All service connections were metered and the utility used a declining block volumetric water rate, similar to the pricing structure of the Kentville water utility.

The information and data used to describe each water utility and to calculate the fi nancial ratios were obtained from two sources: 1) annual fi nancial reports obtained from the Nova Scotia Utility and Review Board; and 2) interviews with water system personnel at each utility. Annual fi nancial records (1990-2002) for each water utility were collected from on-site visits to the Nova Scotia Utility and Review Board in May and July of 2003. Three main annual fi nancial reports were used for each utility to calculate the fi nancial ratios including a Statement of Operations, an Operating Fund Balance Sheet and a Capital Fund Balance Sheet. These records provided information on operating and non-operating revenues and expenditures, operating profi t (or loss), excess of revenue over expenditure, beginning and ending surplus, as well as both operating and capital assets, liabilities and equity.

Additional information was gathered through on-site interviews, as well as communications with water utility personnel at each location in April and May of 2003, and communication with three additional provincial offi cials. The aim was to crosscheck and verify data gathered from the documentary sources, and to gather additional information. Specifi c concerns included the following: basic facts about the systems; challenges being faced by the utilities; types of water rate and pricing structure being used; and impacts of water regulations, standards and guidelines on operations. Additionally, interviewees were asked whether they

thought a gap existed between fi nancial obligations and the means of obtaining fi nancial resources to meet these obligations, and how they thought they could increase the fi nancial resources available for their water systems.

Estimated Financial Impacts of Regulatory Changes

To provide some context for the trends that will be discussed in the section that follows, this section summarizes what was learned through interviews with system operators about the fi nancial costs associated with the regulatory changes. Five regulatory changes were emphasized: the registration of water supply systems; mandatory operator training and certifi cation; compulsory compliance with water regulations and standards; the requirement for chemically-assisted fi ltration of surface water; and the requirement for regular water testing and reporting. These changes and the estimated fi nancial impacts are discussed below.

Only one of the four water utilities reported direct fi nancial cost impacts for registration/classifi cation of its water supply system. Middleton did not already meet the requirements necessary for the classifi cation of its facility. As a result, this utility undertook a facility review study to determine what improvements were required to meet classifi cation and this cost approximately $30,000.

For the most part, the requirement of mandatory operator training and certifi cation had little fi nancial cost impact on the water utilities because most water personnel already met the staffi ng qualifi cations. Kentville was the only utility to report annual refresher training and upgrading costs of approximately $5,000 annually. However, when surface water fi ltration is in place for the water utilities using surface water sources, and if groundwater fi ltration becomes necessary due to surface water infi ltration, added costs will likely occur. Annual costs of all utilities are expected to rise by approximately $60,000 for additional staffi ng and training needs to meet the responsibilities of operating such fi ltration plants.

According to offi cials from the study sites, compliance with water regulations and standards required upgrades and improvements of the existing facilities beyond those that would have occurred through regular maintenance. Unfortunately, the utilities were unable to readily distinguish between capital investments made

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in response to the regulatory changes and those that would have occurred anyway. During the study period, the larger systems, Kentville and Wolfville, invested $6 million and $4.8 million, respectively, in capital improvements. The smaller systems, Middleton and Bridgetown, invested much less money, approximately $1 million and $286,000, respectively. The difference in the amount of money invested in capital refl ects the size of the water system.

As of January 2002, funds from the Canada/Nova Scotia Infrastructure Program were also invested; each level of government (local, provincial, federal) provided one-third. Interviewees indicated that in Middleton, cost-shared infrastructure spending amounted to an estimated $360,000. The amounts for Bridgetown and Wolfville were $180,930 and $890,800, respectively. These funds were being used for projects such as upgrading water mains and transmission lines, covering reservoirs, and retrofi tting facilities.

The requirement for surface water fi ltration affected the utilities differently. The Bridgetown water utility was the only one that used surface water. It anticipated having to spend approximately $2.5 million to build a surface water fi ltration plant, and foresaw an increase in annual operating costs of $30,000 to $50,000. The groundwater dependent systems were also affected by this regulatory change because of the requirement to determine whether groundwater was directly under the infl uence of surface water. The three groundwater-dependent utilities expected costs of $60,000 to $80,000 for conducting the necessary studies. Surface water guidelines would come into effect if their groundwater proved to be directly under the infl uence of surface water, and the utilities likely would have to construct groundwater fi ltration plants at an anticipated cost of between $500,000 and $1.5 million, with increased annual operating costs estimated at $30,000 to $50,000.

The requirement for regular water testing and reporting has increased costs for each of the utilities. In the past, water sampling and testing were covered by the provincial government and had no direct cost for the water utilities. Now, each utility faces laboratory, travel, and labour costs associated with the new testing and reporting requirements. Drinking water is tested for coliform on a weekly basis and for chlorine residuals on a daily basis. Kentville reported having the highest annual cost impacts of $14,000 as a result of this requirement and Bridgetown had the lowest at $4,000.

Is There a Gap in Local Financial Capacity of the Water Systems?

The fi nancial ratios for each utility were calculated over the 12-year period (1990-2002) and are listed in Table 2. The values in bold indicate the measure of fi nancial capacity was in an undesirable range. Generally, the fi nancial capacity of the four systems has been solid, particularly for Middleton where initial low debt coverage levels have risen. However, there are areas of concern. In all utilities over the study period, the expense ratio is well above the desired threshold of 0.4 suggesting there is insuffi cient capital investment. Solvency is an issue for Wolfville and increasingly so for Kentville as the debt ratio is above 0.4 in many of the recent periods. Wolfville also suffers from liquidity problems, as current liabilities are now greater than current assets and debt coverage problems are evident throughout the study period. The fi nancial capacity of Bridgetown has been solid, but appears to have deteriorated recently as the liquidity, profi tability and debt coverage measures are now undesirable.

Regulations and Changes in Local Financial Capacity

The regression analysis provides insight on the extent and direction of changes in the fi nancial capacity measures over time. The interpretation of the estimated coeffi cients listed in Table 3 is provided via a thorough discussion of the values for Middleton. The highlights of the changes in fi nancial capacity for the other three utitlies follow.

The intercept has shifted upwards for Middleton’s solvency measure with the onset of the regulations (β2=0.271), but the trend is now negative (β4 =-0.031). The coeffi cients are consistent with the raw values listed in Table 2 where the debt ratio was increasing steadily before the regulations were enacted and has fallen gradually since. The absolute values and the trend for the solvency measure are thus favourable for Middleton. The same is true for the liquidity measure but the coeffi cients are of the opposite sign since increasing the ratio of current assets to current liabilities is desired. There is no trend in the ratio of cash fl ow to sales as can be ascertained by the annual values of the profi tability ratio in Table 2 for Middleton. However, the mean has increased from a value of 0.318

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Tab

le 2

. Val

ues

of

the

Mea

sure

s o

f F

inan

cial

Cap

acit

y fo

r th

e F

ou

r N

ova

Sco

tia

Wat

er U

tilit

ies

(199

0-20

02).

Uti

lity

Mea

sure

1990

/91

1991

/92

1992

/93

1993

/94

1994

/95

1995

/96

1996

/97

1997

/98

1998

/99

1999

/00

2000

/01

2001

/02

Mid

dlet

onD

ebt

0.28

0.29

0.36

0.38

0.33

0.32

0.31

0.28

0.28

0.28

0.25

0.25

Cur

rent

4.

102.

594.

322.

721.

113.

453.

1330

.01

2.94

3.35

5.24

4.82

Profi

tabi

lity

0.23

0.24

0.40

0.45

0.27

0.49

0.35

0.50

0.42

0.39

0.37

0.35

Cas

h F

low

1.

181.

163.

204.

621.

493.

282.

153.

392.

813.

523.

455.

74O

pera

ting

1.19

1.14

1.42

1.59

1.15

1.57

1.25

1.56

1.37

1.38

1.36

1.31

Sale

s 0.

900.

920.

940.

940.

870.

950.

870.

950.

940.

900.

850.

88E

xpen

se

0.74

0.76

0.66

0.66

0.72

0.79

0.74

0.75

0.54

0.74

0.64

0.69

Rec

eiva

bles

0.04

0.02

0.03

0.02

0.03

0.21

0.24

0.23

0.24

0.24

0.24

0.22

Ken

tvill

eD

ebt

0.49

0.46

0.42

0.40

0.38

0.37

0.38

0.39

0.34

0.29

0.47

0.50

Cur

rent

1.

952.

253.

664.

866.

063.

842.

421.

983.

472.

281.

652.

67Pr

ofi ta

bilit

y0.

400.

380.

380.

340.

470.

460.

520.

520.

460.

540.

480.

48C

ash

Flo

w

1.40

1.61

1.47

1.55

2.57

2.85

3.44

4.06

4.32

6.79

13.1

58.

99O

pera

ting

1.47

1.44

1.44

1.36

1.63

1.63

1.78

1.78

1.61

1.80

1.55

1.56

Sale

s 0.

950.

940.

960.

960.

970.

960.

970.

970.

970.

970.

980.

98E

xpen

se

0.68

0.71

0.69

0.69

0.66

0.66

0.61

0.61

0.62

0.57

0.65

0.73

Rec

eiva

bles

0.

260.

200.

280.

290.

230.

250.

230.

210.

210.

250.

200.

19

Bri

dget

own

Deb

t 0.

300.

280.

260.

250.

250.

240.

220.

210.

200.

200.

200.

22C

urre

nt

2.76

13.7

911

.44

15.4

415

.16

18.2

814

.01

14.2

014

.21

15.8

319

.41

0.51

Profi

tabi

lity

0.45

0.39

0.31

0.34

0.28

0.36

0.35

0.42

0.30

0.20

0.20

0.12

Cas

h F

low

1.

741.

971.

282.

141.

852.

401.

114.

503.

222.

202.

171.

36O

pera

ting

1.58

1.44

1.28

1.32

1.24

1.36

1.33

1.47

1.24

1.10

1.10

1.02

Sale

s 0.

950.

960.

950.

970.

970.

970.

970.

970.

970.

970.

970.

97E

xpen

se

0.65

0.74

0.76

0.77

0.78

0.77

0.68

0.79

0.71

0.91

0.90

0.85

Rec

eiva

bles

0.

300.

230.

290.

280.

290.

280.

290.

300.

280.

270.

290.

27

Wol

fvill

eD

ebt

0.37

0.37

0.34

0.58

0.61

0.57

0.60

0.58

0.61

0.65

0.65

0.64

Cur

rent

9.

232.

828.

872.

191.

842.

120.

971.

301.

101.

110.

630.

81Pr

ofi ta

bilit

y0.

330.

090.

210.

520.

520.

530.

440.

550.

520.

480.

430.

51C

ash

Flo

w

2.50

0.88

3.26

10.8

63.

281.

321.

181.

631.

691.

631.

231.

52O

pera

ting

1.26

1.00

1.15

1.80

1.73

1.71

1.45

1.71

1.64

1.45

1.34

1.56

Sale

s 0.

940.

950.

880.

970.

740.

980.

890.

910.

900.

890.

770.

92E

xpen

se

0.78

0.87

0.88

0.85

0.36

0.58

0.57

0.57

0.56

0.61

0.53

0.59

Rec

eiva

bles

0.

320.

200.

250.

260.

250.

270.

270.

280.

270.

300.

300.

29

Not

e: V

alue

s in

bol

d ar

e ou

tsid

e th

e de

sira

ble

rang

e fo

r the

fi na

ncia

l rat

io m

easu

re a

s lis

ted

in T

able

1.

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Table 3. Regression Estimates of Changes in Financial Capacity Measures.

Regression Estimates

Utility Financial

Ratio

Intercept

(β0)

Intercept×Reg

(β1)

Trend

(β2)

Trend×Reg

(β3)

Adj R-Square

Middleton Debt 0.271(11.18)*

0.117(2.48)

0.019(2.60)

-0.031(-3.62)

0.76

Current 4.723(5.26)

-3.809(-2.19)

-0.585(-2.162)

0.895(2.84)

0.57

Profi tability 0.318(8.88)

0.092(1.96)

- - 0.28

Cash Flow 1.209(1.62)

-1.093(-0.85)

0.373(2.04)

- 0.44

Operating 1.357(29.63)

- - - 0.00

Sales 0.909(88.62)

- - - 0.00

Expense 0.703(35.45)

- - - 0.00

Receivables 0.028(5.80)

0.203(32.18)

- - 0.99

Kentville Debt 0.514(8.99)

-0.273(-2.47)

-0.028(-1.62)

0.044(2.23)

0.46

Current 0.507(0.758)

3.636(2.80)

1.083(5.37)

-1.253(-5.33)

0.83


0.100(4.38)

- - 0.66

Cash Flow 1.036(0.55)

-7.848(-2.18)

0.228(0.41)

1.221(1.87)

0.83


0.205(3.30)

- - 0.52

Sales 0.945(251.90)

-0.007(-1.04)

0.004(4.00)

- 0.81

Expense 0.686(37.32)

-0.050(-2.09)

- - 0.30


-0.032(-1.83)

- - 0.25

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Regression Estimates

Utility Financial

Ratio

Intercept

(β0)

Intercept×Reg

(β1)

Trend

(β2)

Trend×Reg

(β3)

Adj R-Square

Bridgetown Debt 3.07(24.95)

-0.059(-2.46)

-0.013(-3.50)

0.009(2.10)

0.91

Current 3.783(0.70)

23.136(2.20)

2.645(1.62)

-4.105(-2.16)

0.40


0.182(3.59)

-0.043(-5.93)

- 0.83

Cash Flow 2.161(8.064)

- - - 0.00


0.278(3.15)

-0.070(-5.54)

- 0.82

Sales 0.945(208.1)

0.025(2.84)

0.005(3.65)

-0.005(-3.13)

0.78

Expense 0.654(17.80)

-0.111(-1.75)

0.029(3.18)

- 0.60


- - - 0.00

Wolfville Debt 0.247(4.58)

0.245(2.35)

0.069(4.25)

-0.055(-2.93)

0.86

Current 9.613(4.56)

-6.922(-1.69)

-1.541(-2.42)

1.370(1.85)

0.68


0.452(2.09)

0.081(2.41)

-0.086(-2.21)

0.61

Cash Flow 4.156(3.79)

-2.699(-1.88)

- - 0.26


0.984(2.50)

0.174(2.84)

-0.207(-2.90)

0.58

Sales 0.961(21.54)

0.128(1.67)

-0.022(-1.97)

- 0.30

Expense 1.006(7.70)

-0.430(1.70)

-0.086(-2.18)

0.086(1.87)

0.57


- - - 0.00

Table 3. continued.

*Values in parentheses are t-statistics

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prior to the regulations to 0.41 (=0.318 (β0) +0.092 (β1)) after 1994/95. Thus, profi tability has improved on average for Middleton. The trend in cash fl ow has been positive through all 12 years (β3=0.373), but there was an initial negative impact with the imposition of the regulations as indicated by the negative coeffi cient on the interaction term between the intercept and regulatory dummy variable (β2=-1.093). The estimated coeffi cients are consistent with the observed values of the coverage ratio in Table 2, which increased steadily from undesirably low values in the initial periods and then fell in 1994/95 but continued a steady upward movement thereafter.

There were no trends either across periods or across all 12 years for the operating, sales and expense ratios for the Middleton utility. Neither were there changes in average values of these measures of fi nancial capacity as the only variable left in the fi nal regression model consisted of the intercept. While the operating and sales ratios are in the desirable range, the ratio of operating expenses to total expenses is well above the threshold of 0.4. There is no trend in the expense ratio and the average has not changed with the regulations but the lack of capital investment availability remains a concern for Middleton. The only measure of fi nancial capacity that appears to be negatively affected by the legislation is the receivables ratio, which increased from an average of 0.028 before 1995 to 0.231 (=0.028+0.203) afterwards. The timeliness of bill collections may have been compromised due to other management responsibilities resulting from the regulatory changes. While the large relative increase in the accounts receivable ratio was undesirable, the ratio is still within the acceptable range as is the case for the majority of measures of fi nancial capacity for Middleton.

The fi nancial ratios for the Kentville utility are also generally positive as discussed above but the regression reveals some undesirable trends. The debt ratio had been falling but now is increasing and was above the threshold value of 0.4 for the last two years. Similarly, the trend in the liquidity measure shifted after the regulations and is now moving in an unfavourable direction. The rising debt and associated greater current liabilities may be refl ected in the fall in the current ratio. However, there are also positive signs for the Kentville utility. The mean values for the ratios of profi tability, operating, expense and receivables all changed in a desired way after the legislation was

enacted. Similarly, the trends in the cash fl ow and sales ratios are both increasing. Thus, while the debt to asset position of Kentville deteriorated after the regulations, revenue relative to expenses has increased as indicated by the various measures of profi tability.

In contrast to the previous two utilities, the fi nancial ratios for profi tability generally deteriorated for the Bridgetown water system after 1995. While there was an initial shift upwards in the ratio of cash fl ow to total sales, there has been an overall negative trend and the profi tability ratio has been below the threshold value of 0.2 in the last several years (see Table 2). A similar pattern was observed for the ratio of operating revenue to operating expenses, which is also now close to falling below the desired value of 1.0. The solvency measure has been adversely impacted with the regulations, albeit marginally, but is still well below the 0.4 threshold. Liquidity also deteriorated due largely to a signifi cant drop in the current ratio in the last year of the survey, as the utility had been very liquid until that point. In general, the fi nancial capacity of the Bridgetown utility has declined since 1995 as evidenced by the decline in liquidity and profi tability.

The solvency position of the Wolfville utility was the least favourable among the four utilities and it has deteriorated after the regulations as both the mean and the trend of the debt ratio increased after 1995. Similarly, the current ratio did not improve after the introduction of the regulations as it has fallen signifi cantly. Current assets were less than immediate obligations in the last two years of the survey. A similar pattern was noted for the profi tability, operating and expense ratios. Cash fl ow did not match the increase in loan obligations as the mean of the cash fl ow ratio fell from 4.156 to 1.458 (=4.156-2.698) in the second period. The results of the regression analysis suggest that the fi nancial capacity of the Wolfville water utility was negatively affected by the regulations.

Overall, the analysis indicated that the regulatory changes implemented in 1995 did not seriously affect the fi nancial capacity of the Middleton and Kentville utilities. Interestingly, in some respects the fi nancial capacity of certain utilities actually improved following the regulatory changes. There were negative effects of the regulations on the other two utilities, particularly Wolfville. It is important to underscore that all four utilities faced fi nancial challenges before the regulatory changes were instituted. The analysis suggests that in several respects the regulatory changes worsened

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existing problems, while in others they may have caused new problems to occur.

It is clear that other factors besides the regulatory changes infl uenced the fi nancial capacity of the utilities during the study period. First, water rate increases that occurred in three of the four utilities (Middleton, Kentville and Wolfville) had positive effects on their fi nancial health. This should not be surprising, as it is now well understood that utilities must recover the bulk of their expenses from user charges. The utility with the most signifi cant decline in profi tability (Bridgetown) was the only one not to raise water prices. Second, large capital investments were made in the four utilities during the study period beginning in January 2002. The capital investments were largest in the largest systems and these were also the ones with a decrease in their solvency and liquidity due to the increased debt load. Third, cost-shared projects through the Nova Scotia Infrastructure program helped offset the fi nancial burden of the facility upgrades and the relative value from this program was greatest for Middleton whose fi nancial capacity actually improved over time. Fourth, three utilities (Middleton, Bridgetown and Wolfville) were able to address serious shortcomings in the quality of the raw water supplies by switching from surface sources to groundwater. Without this option, the costs of meeting the new water quality standards would have had signifi cant fi nancial repercussions for the utilities.

The regulatory change that may have the most impact on the fi nancial health of the water systems is the requirement that surface water systems must have chemically-assisted fi ltration and disinfection. The Bridgetown water utility is slated to undergo extensive facility upgrades to build a water fi ltration plant by 2008 to meet this regulatory change. This is estimated to cost approximately $2.5 million in capital investment, with $90,000 to $110,000 in increased annual operating costs, including additional labour requirements. If tests indicate surface water infi ltration of the groundwater aquifers used by the other utilities, then they face capital investments of between $500,000 and $1.5 million each, with increased operating costs in the range of $90,000 to $110,000.

Conclusions

No equivalent to the U.S. Safe Drinking Water Act exists Safe Drinking Water Act exists Safe Drinking Water Actin Canada. Thus, attention to the fi nancial capacity of

drinking water systems has been variable across the country and, in most respects, has been a function of provincial initiatives. For example, through its 2002 drinking water strategy, the Province of Nova Scotia has recognized the challenges that small systems face:

Most municipal water systems in Nova Scotia serve small communities. The challenge for many of these small towns and villages is to afford the equipment and qualifi ed operators needed to conform to the province’s drinking water standards. It is important to recognize this and other challenges unique to small communities (NSDEL, 2002a, p. 14).

Financial stability is identifi ed in the strategy as one of three elements that will need to be emphasized to ensure that small systems can provide safe drinking water; the other two elements are affordable technologies and improved training of small systems operators.

The regulatory changes instituted in 1995 had mixed effects on the four Nova Scotia utilities studied. The fi nancial capacity of the Middleton utility actually improved following the regulatory changes while there were negative effects on the other three utilities, particularly Wolfville. However, it is important to note the positive infl uences within the study period that offset the potentially negative impacts of the regulatory changes. A combination of good fortune (being able to switch from surface water sources to groundwater sources), good management (raising water rates to more appropriate levels) and the considerable fi nancial assistance from senior governments (through infrastructure grants established in January 2002) may have minimized the effects of the regulatory changes.

Nonetheless, it is incumbent upon all actors involved in drinking water provision — from those at the local level to senior governments — to be concerned about the fi nancial capacity of small systems. Recognition of the challenges that small systems face is a necessary — but not suffi cient — step. Implementation of actions that build capacity is essential if these challenges are to be addressed effectively. The research presented in this paper points to one essential prerequisite for capacity building; better tools are needed to permit the assessment or measurement of fi nancial capacity. The methodology used to undertake the research presented in this paper builds on tools developed by the Environmental

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Finance Center (2001) and others, with the important addition of a longitudinal perspective that permitted identifi cation of key trends. This kind of analysis permits identifi cation of specifi c areas, such as water pricing, that need to be emphasized in building the capacity of drinking water systems, once basic steps such as instituting full cost recovery have been implemented.

Acknowledgements

This research was made possible through funding from the Canadian Water Network, a Networks of Centres of Excellence. We would like to thank the people in Nova Scotia who participated in the research through providing their time for interviews, and for sharing documents and other resources.

References

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measuring financial capacity and the effects of regulatory changes on small water systems in nova...

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