tel
[415] 777-0487
fax
[415] 777-0244
nature.org
New Prospects for Financing Natural Infrastructure1
A Nature Conservancy White Paper – January 2015
Introduction Sea-level rise, stressed aquatic ecosystems, water quality concerns, increasing flood risk, and aging levees
are driving a need for major investments in flood protection, stormwater management, and wastewater
infrastructure as well as habitat restoration. At the same time, a combination of federal budget cuts and
state voter-approved initiatives has constrained local agencies’ ability to raise funds for such projects.2
One promising approach to overcome these obstacles is through investments in natural infrastructure.
The emerging field of natural infrastructure leverages natural processes to provide multiple benefits —
such as flood protection, aquatic habitat, water quality, and carbon sequestration — potentially at lower
cost than traditional defensive “gray” infrastructure like levees and seawalls.
The “horizontal levee” is a natural infrastructure strategy that aims to address multiple needs in San
Francisco Bay.3 It integrates the inherent flood risk reduction properties of tidal marshes into a shoreline
design that would meet flood protection and habitat restoration objectives while also addressing water
quality issues and providing resilience to sea level rise.
While the horizontal levee is a promising strategy, it also presents new challenges. This paper uses the
horizontal levee as a lens to explore potential solutions to three such issues common to natural
infrastructure projects:
1. Technical performance risk
2. Financial performance risk
3. Need for coordinating investment from multiple stakeholders
Below, we present four approaches that may be useful in overcoming these potential challenges:
1.
2.
3.
4.
Performance guarantees
Pay-for-performance contracts
Coordinated investment vehicles
Monetizing co-benefits
The concepts discussed in this white paper are either novel or novel when applied in this context. Their
application at scale will necessitate additional research, stakeholder engagement, pilots and adaptive
management. This is a starting point that we hope fosters dialogue among stakeholders on the
1
Lead author: Mark Zimring (The Nature Conservancy of California). Co-authors: Eric Hallstein (The Nature
Conservancy of California), Louis Blumberg (The Nature Conservancy of California), Michael Kiparsky (Wheeler
Institute for Water Law & Policy, University of California at Berkeley School of Law) and Jim Downing. Please
direct correspondence to Mark Zimring ([email protected]).
2
Hanak, E., Gray, B., Lund, J., Mitchell, D., Chappelle, C., Fahlund, A., Jessoe, K., Meddelin-Azuara, J.,
Misczynski, D., Nachbaur, J. and R. Suddeth. Paying for Water in California. Public Policy Institute of California.
March 2014. Available at: http://www.ppic.org/content/pubs/report/R_314EHR.pdf (Hanak et al. 2014)
3
For more information on the horizontal levee concept, see pages 3-4 of this report, or
http://www.thebayinstitute.org/publications/the-horizontal-levee 1 possibilities that emerge from combining innovative finance with emerging natural infrastructure
opportunities.
Context: Growing Water Infrastructure Investment Needs and Restricted Funding Much of [California’s] water supply, wastewater, and flood control infrastructure is aging, and
rebuilding typically requires costly upgrades to meet increasingly high standards for water quality and
infrastructure safety. Moreover, the last few decades have seen the arrival of new mandates—and added
costs—for managing stormwater runoff and protecting aquatic ecosystems. Climate change and other
factors are also likely to raise costs and management complexity in the coming decades [Hanak et al
2014]. The costs of meeting California’s water supply, wastewater, stormwater management, and flood
protection needs in an ecologically-sound manner are increasing.4 In many areas, the costs of providing
these services are expanding faster than customer bases, driving increases in per-capita service costs. In
recent years, less than 20 percent of funding to meet these costs has been covered with state and federal
monies, a trend likely to continue. The rest of the burden of meeting these spending needs falls on local
service providers, whose ability to raise the requisite levels of funding is increasingly restricted. In
particular, voter-approved California constitutional reforms severely restrict the capacity of local
stormwater management and flood protection service providers to raise funding without direct voter
approval.5
Conservative recent estimates suggest that California’s funding gap for flood protection and stormwater
management is at least $1.5 billion annually over the next 20 years. While water supply and wastewater
utilities have been largely exempted from these funding restrictions and are in better fiscal health, legal
challenges to their rate structures loom and their customers and regulators may be reluctant to accept
increasing service rates.6
Combined, these funding challenges may lead to underinvestment in modernizing infrastructure as well as
increased performance risks, environmental impacts and long-term operational costs.
The Opportunity: Harness multi-­‐benefit natural infrastructure strategies to cost-­‐effectively provide flood protection, habitat, and water quality benefits
Natural infrastructure strategies such as the horizontal levee may provide planners with powerful new
options to cost-effectively address flood protection, aquatic ecosystem, and wastewater treatment and
4
This section draws on analysis in Hanak et al. 2014.
See Hanak et al 2014 pp. 18-22 for a thorough discussion of the funding challenges Proposition 13 [1973],
Proposition 218 [1996] and Proposition 26 [2010] pose to water-related service providers.
6
See Hanak et al 2014. These legal challenges pertain to voter-approved constitutional reforms which require that
fees for provision of water supply and wastewater management services be assessed based on the cost of service to
the customer. It is unclear whether tiered rate pricing, through which customers using large amounts of water are
charged at a higher per-unit rate than customers using small amounts of water, will be deemed by courts to run afoul
of constitutional reforms. Tiered rate pricing is designed to encourage water conservation and maximize the value
of California’s limited water supply. Without tiered rate pricing, it is reasonable to assume that water consumption
would rise faster among high water users, necessitating the development of additional supply at added expense to all
ratepayers. 5
2 discharge needs. The horizontal levee concept is designed as a multi-benefit alternative to the
conventional approach of raising, reinforcing, and expanding the system of levees and seawalls that ring
the Bay and discharging treated effluent through a large pipe into the middle of the Bay. Such gray
infrastructure strategies are certain to be very costly and stand to degrade aquatic habitats in the Bay.
The Horizontal Levee
The horizontal levee strategy envisions abandoning existing bayshore levees in favor of smaller inland
levees behind restored tidal marsh (Figure 1). Because the restored marsh would substantially reduce
wave energy, a smaller inland levee could provide the same level of flood protection as a large bayshore
levee. Taking advantage of natural wave attenuation in this way promises to reduce levee construction
3 and maintenance costs by more than 40 percent. The strategy would complement ongoing tidal marsh
restoration efforts in San Francisco Bay while also providing necessary flood protection for homes,
businesses, and public infrastructure — notably including nearly two dozen wastewater treatment
facilities — close to the shore.
Where appropriate for the Bay’s ecology and development, the Horizontal Levee concept could be
extended to include additional multiple-benefit features (Figures 2 and 3). The tidal marsh could
transition into gently sloping upland (potentially built using material dredged from local flood channels
and the Bay), which would facilitate landward migration of tidal habitats as sea level rises. These upland
areas could also be used to address issues associated with the disposal of effluent from wastewater
treatment plants, which face increasingly stringent requirements for reducing the nutrient content of the
treated wastewater they discharge. A portion of the treated effluent from these facilities could be used to
irrigate native freshwater marsh vegetation, a strategy that would reduce the flow of nitrogen to the bay
while also reducing the costs wastewater treatment plants incur to pump and discharge effluent and
restoring a lost component of the region’s ecosystem.
Along with potential benefits from novel natural infrastructure approaches, decision-makers need to
consider risks. One can divide these risks into two categories:
1. Technical performance risk: The horizontal levee is an emerging approach and may not deliver
the expected flood protection, water quality, and habitat benefits.
2. Financial performance risk: Uncertainty about construction and maintenance costs, as well as
potential costs associated with poor technical performance, present significant financial risks to
the agencies developing the project, and thus to utility bill payers and taxpayers.
As in other natural infrastructure approaches, the horizontal levee’s potential advantages relative to
alternative technical options available to policymakers and planners have corresponding risks, as would
any developing technology. Table 1 illustrates how opportunities may pair with risks in horizontal levees.
Table 1. Horizontal Levee Opportunities and Risks in the San Francisco Bay
Opportunities
Provide increased flood protection given
anticipated sea level rise
Deliver a range of co-benefits such as habitat
provision, carbon sequestration and recreation.
Contribute to meeting nutrient-load standards
for wastewater dischargers
Insulate customers from upward pressure on
wastewater utility and tax rates by:
• Reducing the need for maintaining and
upgrading existing gray infrastructure;
• Having lower implementation and/or
operational costs than new gray
Risks
Technical Performance Risk:
Uncertainty about whether natural
infrastructure will deliver effective flood
protection, social and environmental cobenefits, and nutrient-load reduction benefits.
Financial Performance Risk:
Even if technical performance is strong,
uncertainty about whether the project will
deliver these benefits cost-effectively over the
long term (i.e., at a competitive or lower cost
4 •
infrastructure projects;
Monetizing co-benefits to reduce the
net costs to customers of implementing
and operating infrastructure.
than gray infrastructure).
Ultimately, the goal of new financing approaches is to re-allocate costs, benefits, and risks among a new
set of players, with the promise of enabling projects that would otherwise not be viable.
Innovative Financing: Mitigating the Horizontal Levee’s Performance Risks Gray infrastructure approaches have been deployed for decades and abundant data exist on their technical
and financial performance. Natural infrastructure has shorter technical, environmental and financial track
records. For planners tasked with providing infrastructure that delivers consistent, predictable service at a
known cost, the risks associated with a novel strategy can outweigh the potential financial and
environmental benefits.
For local agencies already struggling to identify adequate funding to keep pace with spending needs,
investing in cutting-edge approaches, with their attendant performance risk, may simply be too much to
bear. Resulting restrictions on available funding may prevent promising multi-benefit natural
infrastructure benefits from moving from the drawing board to deployment.
Two innovative financing approaches — performance guarantees and pay-for-performance contracts —
have the potential to overcome this challenge by shifting the horizontal levee’s technical and financial
performance risk away from the agencies developing the project (and their ratepayers) to the private
sector.7
1. Performance Guarantees. A performance guarantee is provided by a third party, typically the
contractor tasked with delivering infrastructure improvements. It guarantees that a project will meet a
set of minimum performance standards over a fixed period of time. Should a project fail to meet these
standards, the guarantee provider — again, typically the contractor installing the infrastructure
improvements — is required to compensate the customer for damages based on a pre-negotiated
contract.
A performance guarantee could facilitate moving the horizontal levee from the drawing board to the
field by protecting flood protection service providers, such as the Army Corps of Engineers, from
technical and financial performance risks. A wastewater management utility and/or flood protection
service provider would pay for the horizontal levee’s implementation costs. Should the project fail to
meet performance targets, the contractor or a third party guarantor would be obligated to make these
service providers “whole,” for instance through a cash payment.
7
Note that while these financing structures protect wastewater management and flood protection service providers
from paying for the horizontal levee if it fails to meet technical performance standards and from cost overruns, they
do not alleviate service providers’ need to comply with regulatory mandates [e.g., TMDLs] and deliver consistent
service to customers. The Nature Conservancy believes that responsibly piloting the horizontal levee concept at
small scale today will provide critical data to policymakers, service providers and other key stakeholders on the
efficacy of this natural infrastructure approach so that other strategies can be pursued should it not meet financial or
technical performance standards.
5 Like any insurance policy, performance guarantees
are not free. They may be explicitly purchased as
an insurance contract or, more commonly,
embedded in overall project costs charged by a
contractor.
Performance guarantees would address the variety
of uncertainties associated with a horizontal levee
project. Will the restored marsh accrete at a
sufficient rate to keep up with sea level rise? Will
the marsh restoration come in on budget? Will
ongoing habitat and levee maintenance costs meet
expectations? Will the marsh reduce nutrient
content of wastewater released into the bay
sufficiently to meet regulatory requirements?
Energy Savings Performance Contracts
Performance guarantees are commonly
deployed alongside energy efficiency
projects as Energy Savings Performance
Contracts (ESPCs). ESPCs guarantee that
energy improvements will deliver a
minimum amount of water and energy
savings in a facility over a fixed period of
time, typically 5-10 years. Should the
energy improvements fail to meet this
guaranteed performance level, the guarantee
provider is obligated to make the customer
“whole”, typically through a cash payment.
ESPCs shift the risk that energy
improvements will not deliver expected
energy, water and monetary savings from
the customer to the contractor or other third
party, and, in so doing, enable risk
intolerant businesses and governments to
invest in energy improvements with
confidence.
Should the project fail to deliver on contractual
objectives, the performance guarantee agreement
would specify damages, for example retrofitting a
larger levee or paying out the costs that exceed a
pre-determined project budget threshold. In
exchange for providing this guarantee, the guarantor
would charge the flood protection service provider a premium relative to the horizontal levee’s
expected implementation and maintenance costs over the life of the contract. But, because the
potential cost savings of a horizontal levee are so large relative to a gray infrastructure approach, the
guarantor would expect to earn a reasonable financial return for its risk while still delivering the
project at competitive or lower overall costs to implementation of traditional flood protection
infrastructure.
As better data on the horizontal levee’s performance and risk profile become available, the cost of
performance guarantees should fall.
2. Pay For Performance Contracts. Under a performance guarantee contract, the flood protection
and/or wastewater service provider pays for the costs of implementing and operating the horizontal
levee on an ongoing basis. These costs may then be reimbursed by the guarantor should the project
fail to meet specified performance objectives. By contrast, under a pay for performance [PFP]
contract, contractors or private investors pay for the costs of implementing and operating the
horizontal levee and assume the project’s technical and financial performance risk. These investors
are only repaid by wastewater management and/or flood protection service providers should the
horizontal levee meet pre-specified performance targets such as compliance with TMDL regulations.
Like performance guarantees, investors must be compensated for taking this performance risk. But,
PFP contracts are a potential pathway to overcoming service provider risk aversion and getting pilot
projects built so that stakeholders have more data to inform investment decisions. As with
6 performance guarantees, as better data become available, the risk premium that investors demand to
take on project technical and financial performance risk through PFP contracts will likely fall.
PFP contracts may be particularly valuable in situations where water-related service providers see
value in deferring the costs of implementing and operating projects. Because third parties pay for all
up-front costs, service providers can get infrastructure “in the ground” while paying for it—if it meets
performance objectives—in the future. However, this payment deferment is likely to come at a
financial cost relative to a performance guarantee contract as private sector investment capital is
likely to be more expensive than public or ratepayer capital.
Each of these financing tools may be deployed in the short or long term. As a bridge strategy, these tools
could help to overcome the initial barrier to horizontal levee implementation presented by a lack of
performance data. In the long term, should horizontal levees perform well, wastewater management and
flood protection service providers could either continue to leverage these novel financing tools, or revert
to more traditional infrastructure financing strategies.
Coordinating Stakeholder Investment in Multi-­‐Benefit Projects In addition to shifting the horizontal levee’s technical and financial performance risk away from
wastewater management and flood protection service providers, it is necessary to coordinate investment
in integrated projects like the horizontal levee across the institutions and other stakeholders charged with
delivering these services. Given the complex, multi-jurisdictional nature of large scale natural
infrastructure projects, new vehicles may be necessary for project funding and administration.
Options exist to address these potential financing and governance challenges. One relevant example is a
Joint Powers Authority [JPA]. JPAs are quasi-public entities permitted under California law to raise
funding and jointly exercise power common to their public agency members. They are commonly used
when an activity naturally extends beyond the geographic boundaries of a single existing public authority
or where there are other benefits to coordinated investment, such as economies of scale. Traditionally,
JPAs have been formed among multiple agencies responsible for delivering the same service, such as
flood protection. For example, the Oro Loma Sanitary District, Castro Valley Sanitary District and the
Cities of Hayward and San Leandro are members of the East Bay Dischargers Authority (EBDA), through
which they collectively manage wastewater treatment and disposal.
In some cases, a JPA could be created (or an existing JPA expanded) among agencies responsible for
delivering different services — flood protection, stormwater management, endangered species protection
and wastewater treatment, for instance — to support co-investment in a multi-benefit project like the
horizontal levee. In cases where non-public or Federal entities (e.g., the Army Corps of Engineers) are
responsible for providing services such as flood protection, a cooperative agreement between the JPA and
these non-public or Federal stakeholders could be implemented that covers project funding and
governance responsibilities.
For public service providers seeking financing — as opposed to using cash reserves — for the up-front
costs of a horizontal levee, JPAs may provide a clear advantage. Unlike public service providers, a JPA
can issue revenue bonds to fund projects like the horizontal levee without having to gain voter approval,
provided that each of the member agencies adopts a local ordinance and gains approval from its board of
7 directors.8 Bonds issued to fund a single or multiple natural infrastructure projects would then be repaid
with funds from fees charged to member agency customers, taxes or other pre-determined member
sources of revenues.
Identifying vehicles like JPAs to drive coordinated investment is critical to the long-term success of
natural infrastructure investments because of the need to monetize the multiple benefits accruing to
project stakeholders.
Monetizing Co-­‐Benefits Water-related service providers, in some cases organized into a JPA to coordinate project management
and funding, would be primarily responsible for paying for a horizontal levee since they would receive
the preponderance of the benefits from this concept. The narrow benefits accruing to these stakeholders
(e.g., lower-cost, resilient infrastructure, and compliance with environmental quality regulations) may be
sufficient, on their own, to justify investments in this natural infrastructure approach.
The horizontal levee may also deliver a range of other public benefits. For example, the tidal and
freshwater marshes that would be installed seaward of the earthen levee may create critical habitat for a
range of species of concern, sequester carbon and have substantial recreation value.
Significant co-benefits potentially can be monetized by a variety of public and private funders. In some
cases, there are active markets for these co-benefits and credits or offsets can be developed for sale (e.g.,
carbon credits or development mitigation). Other co-benefits, such as recreational value, may be more
difficult to monetize through existing markets, but may create financial value that can be recognized in
other ways. For instance, investments of public and philanthropic capital such as state and local parks
funding or community foundation support can serve to recognize and capture recreational value.
These potential horizontal levee co-benefits create value relative to traditional single-purpose grey
infrastructure approaches. Tapping multiple entities (e.g., flood control, water quality, and wildlife
agencies) to jointly fund a project in recognition of these diverse benefits can reduce the costs borne by
any single institution, including those responsible for delivering flood protection and wastewater
treatment services to San Francisco Bay communities.
Conclusion Financing and governance structures may play important roles in catalyzing the implementation of natural
infrastructure pilots like the horizontal levee by shifting technical and financial performance risk to the
private sector and coordinating access to project funding across multiple agencies. Monetizing a project’s
co-benefits may help to reduce the long-term costs of upgrading California’s water-related infrastructure
to meet ecological, social and economic objectives.
This white paper has described several options in broad brush strokes to stimulate discussion. Naturally,
there is a need for additional research and experimentation before these tools, and natural infrastructure
concepts like the horizontal levee, can be successfully applied at scale.
8
Voters can force an election, but this is a rare occurrence.
8