Accounting for Inflation in Water and Wastewater Capital Planning

By Dr. Ahmed Rachid El-Khattabi

Across the country, utilities face unprecedented infrastructure investment needs. Federal funding initiatives such as the Infrastructure Investment and Jobs Act (IIJA) have poured billions into water and wastewater projects, driving visible increases in capital spending. Yet these increases reflect not only expanded construction activity but also rising construction costs.

For effective financial planning and capital improvement plan (CIP) development, utilities must distinguish real investment growth from inflation-driven cost increases. Planning future capital projects requires estimating not just what a project would cost today, but what it will cost in five, ten, or even twenty years. Rate paths, debt issuance strategies, reserve policies, and grant applications all depend on understanding future construction cost levels. Without a clear measure of construction cost inflation, utilities risk misinterpreting spending trends, underestimating future capital needs and setting rates too low. This can then lead to deferred maintenance, unexpected borrowing, or sudden rate shocks. Additionally, funded capital projects often face challenges in reaching completion due to rising construction costs.

There is no one way to forecast future construction costs and therefore not everyone uses the same method to calculate future costs of capital projects. Some utilities seek out guaranteed pricing. Others employ sophisticated cost-escalation models. Many simply estimate project costs in today’s dollars and then apply an inflation factor to project spending into the future—this is the approach adopted by the EFC in its free do-it-yourself Capital Improvement Planning tool. But what should that factor be? How high should the assumed rate of cost escalation go, especially in a sector facing rising materials costs, tight labor markets, and supply chain volatility?

This article explains why traditional inflation measures like the Consumer Price Index – Urban (CPI-U) are insufficient for utility capital planning, reviews available construction cost indices, and demonstrates how utilities can construct a transparent, publicly available index using publicly available data from the Bureau of Labor Statistics (BLS).

Construction Spending Reflects Activity and Inflation

The U.S. Census Bureau’s Construction Put in Place (CPIP) data is a valuable way to track dollars spent on public infrastructure. It measures the value of construction work completed in a given period, including materials and labor, on both public and private projects. For water and wastewater, CPIP can act as a proxy for construction-based infrastructure spending, providing insight into:

• investment trends over time
• effects of federal and state stimulus programs
• industry response to regulatory and economic conditions

In the graph below, the total amount of spending on both water and wastewater infrastructure over the last 20 years are plotted. Both water and sewer infrastructure construction spending show a clear long-term upward trend, though with substantial cyclical swings. Spending for sewage systems consistently exceeds that for water systems. Spending for both categories peak leading up to the 2008 financial crisis, dip during the recession, and then resume growth, with notable acceleration starting around 2016.

It may be tempting to treat rising construction spending as a measure of inflation, but CPIP data are reported in current dollars that combine real growth and price changes. For reference, current dollars show actual spending at the time, while constant dollars show spending in “today’s terms” for comparison over time. From these data, it is therefore not possible to get an estimate of inflation alone.

Consumer Price Index Is Not the Right Tool for Utility Capital Costs

The CPI-U measures inflation in a basket of goods and services consumed by households. Though useful for affordability analysis and rate communication, it does not reflect the specialized inputs that drive water and wastewater infrastructure costs.

The CPI-U measures price changes for a household basket of goods and services such as food, housing, energy, and medical care. A utility’s “basket,” by contrast, includes concrete, steel, pumps, and skilled labor. Because these inputs differ so widely, CPI-based adjustments can misstate construction inflation and distort capital forecasts.

Industry Standard Construction Cost Indices are Useful but often Proprietary

Industry-standard construction inflation indices include Engineering News-Record (ENR) Construction Cost Index (CCI), ENR Building Cost Index (BCI), and RSMeans Construction Cost Index. These indices track construction labor and key materials and are widely used by engineers and capital planners. See this previous EFC blog post that discusses the ENR’s CCI.

These indices, however, are typically subscription-based and offer limited transparency. For utilities seeking defensible and repeatable inflation factors, these paywalled sources can be challenging.

The BLS’ Producer Price Index Data as a Free Alternative

The Bureau of Labor Statistics (BLS) Producer Price Index (PPI) offers a free, transparent alternative. Unlike the CPI, which tracks prices paid by consumers, the PPI measures prices received by producers and includes many of the inputs that drive utility capital and operating costs. The table below includes some example series from the BLS:

The only series in the table above that is rather limited in its usefulness is the series related to wages for utility staff. This series (and other similar series that the BLS collects related to wages for water sector operators) are only available starting in either 2023 or 2024. A useful alternative would be to use the Labor Compensation for Utilities: Water, Sewage and Other Systems (NAICS 2213) in the United States (series no. IPUCN2213L021000000) series collected by the US Census.

Using these series, one can combine them into a single measure by type of expenditure, for example by taking a simple average of the indices. The graph below shows construction and O&M cost indices derived from a simple average of selected PPI series. In this example, the Labor Compensation US Census series instead of the wage-related PPI series given data availability. The PPI series for industrial equipment in both the construction and O&M cost indices. For reference, the CPI-U is also included in the graph. All values are normalized (index value=100) at the start of 2012.

As shown, all three indices show a general upward trend, reflecting increasing costs over time. CPI-U rises steadily indicating gradual inflation in overall consumer prices. The construction cost index grows moderately early in the period but accelerates sharply after 2020, likely reflecting the pandemic and resulting supply chain issues, before dipping slightly and leveling off at what seems to be a new, higher trend. Overall, the last five years corresponds to roughly a ~45% increase. Compared with a 24% increase in the CPI over the same period, this increase highlights rapidly rising construction costs in recent years. The O&M Cost Index shows more variability, peaking in 2021 before stabilizing through 2025. Overall, construction costs have grown the fastest, O&M costs display the most volatility, and consumer prices have increased steadily but at a slower pace than either construction or O&M costs.

To apply these trends in a CIP, utilities can convert the computed index into an annual inflation factor. The average annual percentage change in the construction cost index, shown in the graph below, provides a straightforward estimate of how costs are expected to grow each year based on recent historical trends, offering a transparent, data-driven approach to budgeting for inflation. Over the past five years, the average annual percentage change for capital costs is around 8.0%, meaning a project costing $1 million today would be expected to cost about $1.08 million one year later and roughly $1.17 million after two years if compounded. For reference, the average percentage over the past five years for O&M costs and CPI-U are approximately 6.1% and 4.4%, respectively.

Though using PPI data provides a transparent, readily accessible way to track sector-specific cost trends, it is not a perfect proxy for a specific utility’s construction costs. PPI series are generally national so may not fully reflect local labor market dynamics, regional material pricing, supply-chain pressures, or specialized utility construction practices. In addition, the mix of inputs in federal PPI categories may differ from the specific materials and services a given utility relies on.

To help address these limitations, utilities can refine the index to reflect the composition of their actual construction spending. Specifically, a utility can create a customized index using different PPI series that best match its expenditures. When selecting PPI series and constructing a customized index, utilities should keep several technical considerations in mind:

• The BLS puts out series that are either in current dollars or constant dollars. The BLS provides series in either current dollars or constant dollars. It is important to treat all series consistently and avoid mixing current-dollar and constant-dollar series within the same index. When building an inflation index, you should generally use series in current dollars (nominal values), since constant-dollar series have already been adjusted for inflation. Including constant-dollar series would essentially result in discounting for inflation multiple times.
• Different series may be available for different time periods. When combining them, need to make sure that they are all normalized to use the same base period to ensure comparability in each year.
• The BLS also offers series that are either seasonally adjusted or not seasonally adjusted. The seasonally adjusted series are useful for comparing costs month-to-month but less appropriate in the context of understanding total spending. Seasonally unadjusted series would be more appropriate for historical trend analysis and for capital budgeting exercises.
• Many of the series offered by the BLS are discontinued. This means the BLS has stopped publishing the series, so while historical data are available, no new data will be provided. If a utility is creating a process intended to be replicated in future analyses, it is best to use series that are not discontinued to ensure continuity.

Similarly, a utility can further customize the index by using weighted average approach rather than the simple average approach used in the example above. A weighted average approach would be particularly useful for a utility seeking to closely align the index with their actual expenditure patterns. To do so, a utility can use information from its budgets or audited financial statements to assign weights based on the share of total capital costs each category represents.

Regardless of the approach used, utilities should periodically validate their index by comparing it against recent bid tabs, engineer’s estimates, and contractor feedback. Doing so can help maintain confidence in forecasts and support informed CIP planning.