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THE ABCs OF UTILITY FINANCING

Pay-As-You-Go vs. Long-Term Financing

Who should pay for infrastructure that will serve the community for 50 to 70 years?

The Short Answer

Pay as you go asks today’s customers to pay most or all of a project’s cost now. Long-term financing spreads the cost across the years the project is used. Financing includes interest, but it can reduce sudden rate pressure, preserve reserves, avoid higher construction costs caused by delay, and allow future customers who benefit from the project to help pay for it.

What Pay-As-You-Go Does to Rates

Under a pay-as-you-go approach, a utility raises money before or while it builds a capital improvement project. Because the money must be collected over a short period, current customers carry nearly the entire burden.

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For HCSD, water and sewer rates have increased, or are scheduled to increase, by approximately 88% over five years. That increase is being borne by everyone using the system today, including senior citizens, people living on fixed incomes, working families, renters, homeowners and local businesses.

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The basic fairness problem is easy to see: customers today are being asked to pay quickly for pipes, tanks, pumps and treatment facilities that may remain in service for 50 to 70 years.

Why Families Use Financing

Most families do not pay the entire cost of a long-lasting purchase on the day they receive it. They spread the payments over time because they will use the purchase for many years.

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A home is usually purchased with a mortgage. A car is commonly purchased with an auto loan. A new roof, heating system or major home improvement may be financed. Businesses finance buildings, equipment and vehicles that will produce value for many years.

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Utility infrastructure follows the same basic idea. If an improvement will serve several generations, carefully chosen low-interest financing allows those generations to share the cost.

What Long-Term Financing Changes

Long-term financing allows a utility to build a needed project now while spreading the payments over many years. Current and future customers who benefit from the infrastructure share its cost.

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This approach can reduce sudden pressure on rates, preserve reserves for emergencies and other priorities, and avoid higher construction costs caused by delaying necessary work.

Interest Is Real—but not the Whole Calculation

A loan is not free. The utility pays interest, and every proposed loan should be examined carefully. But adding up all future interest payments without considering when those payments are made gives an incomplete picture.

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A fixed loan payment stays the same in dollars. Inflation gradually reduces what those dollars can buy. In other words, a dollar paid 10 or 15 years from now usually has less purchasing power than a dollar collected from customers today. This is called the time value of money.

What History Tells Us About a Future Dollar

Federal Consumer Price Index data show that prices increased approximately 36% from 2015 through 2025 and approximately 48% from 2010 through 2025. If the future resembles those historical periods:

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10 years from now: One future dollar would equal about 74 cents today, and a fixed $510,000 payment would equal about $376,000 today.

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15 years from now: One future dollar would equal about 68 cents today, and a fixed $510,000 payment would equal about $346,000 today.

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This does not make interest disappear. It means inflation can offset part of the interest cost in real, inflation-adjusted dollars. When the financing rate is close to inflation, the real economic cost of borrowing can be much smaller than the total interest printed on the loan schedule.

A Simple $10 Million Example

Assume a necessary utility project costs $10 million today, lasts at least 50 years, and is financed over 30 years. Also assume construction costs rise 4% per year. We will show fixed financing at both 3% and 4%. These are illustrations, not an estimate or loan offer for a specific HCSD project.

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Choice One: Build Now and Finance It

The project is placed in service now. Payments are shared across current and future customers, and each fixed payment becomes smaller in purchasing power as the years pass.

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At a 3% fixed rate: The annual payment would be approximately $510,000. Total payments would be approximately $15.3 million, including $5.3 million in stated interest.

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At a 4% fixed rate: The annual payment would be approximately $578,000. Total payments would be approximately $17.3 million, including $7.3 million in stated interest.

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Choice Two: Delay and Collect Cash First

If construction costs increase by 4% annually, the same $10 million project would have an estimated cost of:

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  • Build today: $10 million

  • Wait 10 years: $14.8 million—an increase of $4.8 million

  • Wait 15 years: $18 million—an increase of $8 million​

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The added cost does not necessarily buy a better project. It may simply reflect higher prices for labor, materials, equipment and construction.

What If the Utility Saves and Invests the Money?

Suppose the utility already had $10 million and earned 3% annually while waiting. After 10 years, it would have about $13.4 million, but the project would cost about $14.8 million—a shortfall of approximately $1.4 million.

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After 15 years, it would have about $15.6 million, but the project would cost about $18 million—a shortfall of approximately $2.4 million.

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If construction costs rise faster than investment earnings, waiting creates a growing shortfall.

Delay Can Create Other Costs

Older infrastructure does not stop aging while money is collected. Delay can mean repeated repairs, service interruptions, additional engineering, regulatory problems or an emergency failure.

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Emergency work is often more expensive and allows less time for planning and competitive bidding.

The ABC Test for Every Major Utility Project

Ask whether the project is truly needed. What is its condition, urgency and expected useful life?

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Bring in every outside funding source first. Look for grants, subsidized government loans and other assistance before placing the cost on rates.

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Compare the full choices. Consider the loan rate, construction inflation, investment earnings, repair costs, reserve needs and the effect on customer rates.

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Do not borrow automatically. Finance projects when the numbers, timing and public benefit support it.

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Explain the decision plainly. Ratepayers deserve to know what the project costs today, what delay could cost and who will pay under each option.

The Bottom Line

The choice is not simply interest versus no interest. The real choice is between collecting most of the money from today’s customers or spreading a necessary, long-lasting investment across the generations that will use it.

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For well-planned projects, low-interest financing can reduce immediate rate pressure, protect reserves, avoid the rising cost of delay and distribute the cost more fairly.

Sources and Important Notes

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Inflation examples use the U.S. Bureau of Labor Statistics Consumer Price Index for All Urban Consumers. CPI measures general consumer prices, not utility construction prices. Future inflation, construction costs, interest rates and investment earnings cannot be guaranteed. Every project requires its own financial comparison. The approximately 88% HCSD rate figure is the local five-year figure supplied for this primer.

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California State Revolving Fund rates are not permanent offers. The Clean Water program generally sets its rate at one-half of the state’s most recent general obligation bond rate when financing is approved. Eligibility, available funds and final terms must be confirmed for each project. The 3% and 4% examples in this primer are illustrations only.

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Sources:

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