My name is Jeff Hughes and I am the Director of the Environmental Finance Center at the University of North Carolina. We are one of nine environmental finance centers across the country created to identify and address the finance challenges related to protecting and managing our nation’s environmental resources. Our center currently works primarily on drinking water and wastewater infrastructure issues. We recently completed an applied research project in which we examined the current status of water infrastructure services, needs, and funding throughout Appalachia. Over a period of two years, we visited numerous communities; interviewed and surveyed hundreds of local, state, and federal officials; and analyzed needs, funding, environmental, and demographic data from throughout the region.

I would like to briefly present what we uncovered, particularly in relationship to the type of water and wastewater support provided by the ARC.

Background
As you know, the way in which water and wastewater services are funded in the United States changed dramatically from the 1970s to the 2000s. The country moved from a sizable federal wastewater grant program that accompanied the passage of the 1972 Clean Water Act to a more complex system in which a smaller amount of funding is delivered through grants and loans administered by a wide variety of federal and state agencies including the ARC. Around 2000, several national studies concluded that the level of spending on water and wastewater services in this new, more complex system is inadequate to meet the nation’s needs. Some studies quantified the needs, other quantified the gap between the need and what was likely to be available to meet the need. These numbers were quite large and as they were intended to do, caught the attention of many policy makers, funding agencies, and the media. Looking at these state level and nationwide studies, it was difficult to disaggregate the situation in a region like the ARC that cuts across state boundaries.

While we began by trying to look at the 410 county ARC region as a unit independent of the rest of the country, one of the first things that became obvious to us was that from a water quality standpoint, the boundaries of the water resources of the region can not be separated from the rest of the country. The familiar saying “What goes on in ____, stays in _____!” definitely can not be applied to water quality in the ARC. Water quality protection successes and failures flow downstream without regard to political boundaries. Federal policy makers should realize that Appalachia is home to the headwaters of almost all the important rivers of the eastern United States. Thus whatever happens to Appalachian waters has major consequences far beyond the 410 counties within the ARC region. Our work and findings revolved around a series of policy questions as follows:

What is the Current State of Water and Wastewater Services in Appalachia?

• Coverage by community water systems—that is, systems that provide water to the public for human consumption and serve at least twenty-five year-round residents—has expanded significantly in the last fifteen years in Appalachia (to reach 74 percent of the population) but still lags significantly behind national coverage (85 percent of the population). Wells remain the primary source in some subregions (more than 75 percent of households in portions of the Appalachian Highlands).

• More people in Appalachia (33 percent) are served by small and medium-sized systems than people in the nation (20 percent) are. In general, the smaller the system, the higher the costs.

• Community water systems in Appalachia rely much more heavily on surface-water sources than systems in the nation as a whole do—18 percent versus 11 percent. Systems that rely on surface water tend to have significantly higher operating and capital costs than systems that treat groundwater.

• Proportionately more people in Appalachia than in the nation as a whole rely on onsite wastewater disposal. In 1990, the last year in which national data were collected by the Census Bureau, about 75 percent of U.S. households reported being served by public sewers, versus 52 percent of Appalachian households.

• In the scattered Appalachian places where careful surveys have been made, substantial numbers of people have failing onsite systems or no wastewater treatment systems at all. In many parts of the region, some individual systems are nothing more than “straight piping” (discharge of waste directly into a stream).

• Some of the highest-quality and most outstanding resource waters in the eastern United States are in Appalachia, but in many areas, surface water and groundwater are seriously impaired. For example, West Virginia has 878 impaired streams, covering approximately 6,170 stream miles.

• Water and wastewater infrastructure and services in Appalachia are intrinsically linked to and influenced by the natural environment of the region. Most of the environmental factors in Appalachia lead to higher costs, especially in the Highlands.

What are the Critical Infrastructure Needs in the Region?

• Appalachia accounts for about $26 billion of the drinking water and clean water needs documented or projected in recent EPA surveys completed in 1999 and 2000. These survey numbers clearly represent a lower limit on the entire water and wastewater needs of the region, and even the EPA does not assume they are an accurate representation of true need. The surveys omit or underreport many needs either because of their definitions of what constitutes “need,” their methodologies, or their rate of nonparticipation.

• This estimate does not fully include many categories of needs that are disproportionately high in Appalachia, such as improvements to failing septic systems, extension of service to people with inadequate or no central water and wastewater treatment, watershed restoration for areas impaired by historic resource extraction and industrial activity, and better stormwater handling. Nor does the estimate include the funds necessary to operate and maintain new facilities or facilities that been neglected. Including these other needs likely raises the region’s total capital requirements to $35–$40 billion.

• Several states carry out needs surveys that are separate from the EPA surveys. Their definitions of “need” and their methodologies differ widely. The more comprehensive surveys that some states have carried out have uncovered needs not reported in the EPA surveys.

What Public Funding Options Are Currently Available to Meet Critical Infrastructure Capital Needs?

• Relatively few communities in Appalachia, especially in economically distressed counties, have credit ratings for water and wastewater purposes from major rating agencies. This lack of creditworthiness limits their direct access to the private capital market.

• Federally supported and coordinated programs disbursed about $3.6 billion to Appalachian communities for water and wastewater projects between January 1, 2000, and December 30, 2003, and state programs disbursed about $1 billion. More than $1.5 billion was provided to communities as grants, and about $3.1 billion took the form of loans.

• The special programs established by individual states accounted for 22.8 percent of the public fund investments. Such programs have been important in some states and nonexistent in others. States in Appalachia employ vastly different funding strategies, which lead to major differences in the types of assistance and incentives that reach local communities.

• Capital funding comes from a wide variety of independent and autonomous sources, making planning and management of applications, and timing of grants, loans, and matches a significant challenge for communities.

• The number of public funding programs and the amount of public funding to upgrade existing decentralized wastewater systems in Appalachia or build new, decentralized ones are extremely limited.

• Funding sources for project planning and other up-front aspects of water and wastewater projects are relatively few. ARC remains one of the few sources of grants funds available for planning.

What Types of Gaps Exist, and What Is the Capacity to Bridge Them?

• At the system level, many small utilities have insufficient revenues to cover future cash-flow requirements, once debt repayments and increased operating costs linked to necessary planned facilities are taken into account. These utilities are characterized by small and often shrinking customer bases. In some cases, even if grants for capital were available, the utilities would be unable to meet the operating costs associated with their facilities.

• In comparison with the nation as a whole, households in many Appalachian counties are paying a higher proportion of their income for water and wastewater services, so high in several areas for large numbers of households that asking them to pay more for improved service is infeasible. This household affordability gap has become the critical challenge for many utilities.

• Management shortfalls in the region range widely. At one end of the spectrum, some small systems are unable to support trained and educated staff. At the other end, some large systems have yet to shift from a reaction-oriented paradigm characterized by high maintenance costs and continual capital stock crises, to a more aggressive approach that includes asset management systems, proactive investments, and continual staff training. What Financial Management and Funding Strategies Are Likely to Have the Biggest Impact on Service in the Region?

• In general, no single strategy or group of strategies identified in recent national studies of water and wastewater infrastructure will close the gap between services and needs in Appalachia as a whole. Instead, strategies must be designed and deployed on the basis of particular community characteristics.

• Regionalization—with its attendant consolidation of providers—offers widely varying possibilities for achieving economies of scale in Appalachia. It has helped some communities pool their resources and reduce costs enough to remain viable. However, some states have a history of regional entities and have institutional and regulatory frameworks favorable to regional systems. Other states have a go-it-alone culture, a historic model of a single provider prevalent in their system of government, and a relative lack of tested regional models. Promoting regionalization in these latter states requires addressing the structural obstacles. ARC funding has played a role in many complicated regionalization projects.

• Appalachia has shown that many communities can contribute to meeting their needs but many cannot generate adequate revenue to meet future needs with price increases alone. The ability to implement “full-cost pricing”—that is, setting rates at a level that generates sufficient revenues to cover all the capital and operating costs of providing service—offers only limited promise for bridging the capital gap in many parts of Appalachia, particularly in small and low- or negative-growth communities. Without external subsidization, many of these systems may collapse completely or slowly decline because of lack of system maintenance and investment.

• Some funding programs encourage or require communities to follow the principles of full-cost pricing to the extent possible before receiving funding. Such inducements or requirements often result in greater community contributions, showing that affordability constraints were less than previously stated.

• Privatization offers some communities a way to attain the economies of scale that regionalization brings, as well as access to greater technical and managerial capacity than is likely in a go-it-alone approach. However, private systems often have few financial incentives to reach the most remote and difficult-to-serve communities in Appalachia.

• Improved management strategies and expanded capital investments often carry a cost in terms of higher customer rates. “You get what you pay for” is a dangerous public health truism. What Steps Can Funding Agencies and Technical Assistance Providers Take to Improve and Expand Service in the Region?

• For many communities with marginal fiscal capacity, careful manipulation of funding terms may offer the best hope of stretching limited public dollars. In some situations, long-term loans (for thirty or forty years) can make a capital project feasible for a community.

• The degree of cooperation and coordination among different funding programs varies significantly across Appalachia. Some states have coordination strategies and institutions that streamline local funding requests and assist in matching and optimizing different funding sources. In other areas of the region, the go-it-alone approach requires individual communities to navigate the complex funding options and seek the best deal they can get.

• External grant funding remains an essential component of an overall funding strategy. Without a significant amount of such funding, a certain number of communities would be unable to generate sufficient revenue to protect the public health and their surface-water quality. Some states in the region have integrated funding programs and strategies that rely on small amounts of grants to leverage loan funds, enabling communities to access the capital they need while covering the majority of the costs themselves.

• Some individual funding programs and some groups of funding programs carefully design funding packages that include a mix of grant and loan funding. In states where such coordination is weak and grants are not strategically linked to loans, communities consistently seek out grant funding even if they clearly have the ability to take on loan financing.