CAPEX or OPEX? Lines Blur for Water Utility Spend

15 Feb 2017  |  Keith Hays

Municipal water utilities are looking for new financing approaches as they face the familiar challenges of massive capital improvement costs, rising operational expenditure, and razor-thin operating margins–all issues we’ve covered in depth in our US and European municipal water infrastructure reports. The predictable revenue streams from water supply and sewerage services should provide ample base for low-cost finance. But several market drivers, including falling revenue and supply insecurity, are forcing utilities to re-think their financing model for an array of key items from pump procurement to cloud computing.

Shift to TOTEX

Ofwat’s 2013 methodology shift in cost assessment modeling for its 2014 pricing review marked a key event that blurred the lines between CAPEX and OPEX. The UK regulator introduced TOTEX – a combined metric for utility business plans. This approach seeks to more accurately capture life-cycle costs of assets, beyond the initial outlay. It also forces a broader re-think of asset management and financing strategies. The TOTEX approach is also extending beyond the UK to other European markets such as Italy, starting in the electricity sector. Water utilities in Europe’s leading urban markets spend over US$15 billion annually on OPEX, and are eyeing sub-segments within the ‘other’ category of their budgets for efficiency gains in terms of what they procure, and how they procure it. OPEX or CAPEX?

Blurring the Lines

The quest for the optimal balance betwen OPEX and CAPEX invites innovative finance models for the water industry. Vendor finance is one obvious area where instead of more onerous municipal bond issuance for capital improvements, utilities may explore incorporating certain items as ongoing upgrades in their operations – a demand trend that Key Equipment and Xylem aim to exploit in the US.

As water utilities increase their levels of digitalization, supplanting physical servers with cloud computing also raises issues of how to account for those fixed, virtual assets — which would move IT OPEX into CAPEX. Oracle’s recently completed surveyindicates this is not a futuristic concept, with 45% of 100 utilities already using cloud-based solutions and regulators paying serious attention to their value as a capital expense eligible for rate-basing.

Positioning in a Blurred World

The switch from CAPEX to OPEX, and vice versa, has a ripple effect across the value chain, especially as many players migrate to a software-as-a-service (SaaS) model. Metering companies target data analytics in their move towards a service model. Software players aim to find the right balance between a project-consultant approach to position their products, versus straight up licensing. The output of these firms’ network intelligence shapes how utilities manage their assets, and in turn the opportunity for other equipment supply.

For any of these firms to close a deal, they will have to get comfortable with utilities’ evolving approach to the CAPEX/OPEX question as more assets become digital, and changing definitions one-off versus recurring expenses find their way into tariff structures, capital improvement plans, and operating budgets. This may not only apply to Internet of Things items like sensors and data platforms, but also to more conventional items such as pumps or basic network instrumentation.