Public utility rating agencies, investors overlook water risk
December 10th, 2010 by Jim JustGrowing water scarcity is a hidden financial risk for investors who buy the water and electric utility bonds that finance much of the U.S.’s water and power infrastructure.
That’s the conclusion of a new report by Ceres and Water Asset Management titled Water Risk in the Municipal Bond Market. More extreme droughts, surging water demand, pollution, and climate change are growing risks that threaten water supplies in many parts of the United States, especially the West, Southwest, and Southeast. For example:
- The City of Atlanta’s water supply could be cut by nearly 40 percent as early as 2012 due to the ruling of a federal judge.
- Lake Mead, the vast reservoir for the Colorado River, is quickly approaching a firstever water shortage declaration that would reduce deliveries to fast-growing Arizona and Nevada.
- Hoover Dam, which provides hydropower to major urban centers in California, Arizona, and Nevada, may stop generating electricity as soon as 2013 if water levels in Lake Mead don’t begin to recover
- More regular droughts and heat waves are likely to increase the operating costs of power generators in the Southeast, among them the Tennessee Valley Authority, which was forced to slash power generation for two weeks at three of its facilities in Alabama and Tennessee because of heightened water temperatures, costing the utility an estimated $10 million in lost power production.
Failure to include growing water risks means ratings agencies, and investors, and even utilities themselves aren’t realistically assessing the ability of public water and electric power utilities to repay their debt. Reduced revenues caused by water supply shortfalls can compromise the value of utility bonds in two ways. First, reduced revenues can undercut a utility’s ability to make timely payments to bond holders, potentially leading to default. Second, diminished credit capacity of a utility may result in a negative outlook or financial stress that may reduce the price of the bonds when sold on the secondary market.
To quantitatively assess a utility’s exposure to water undersupply, the model used in the study simulates the projected levels of monthly water flows from water sources used by the utility and compares the available water to the utility’s monthly demand. The simulations evaluated four different climate change scenarios with varying expectations of wet and dry weather, and with various stress scenarios that would constrict water supplies for one- to five-year time frames. The model was applied to eight investment-grade, 30-year public utility bonds: six water bonds and two electric power bonds, all in regions with growing populations and increasing pressures on water supplies.
Among the key findings for the six water utility bonds:
- The Los Angeles Department of Water & Power’s water system bond received the highest risk score of all water utilities, based on tight restrictions on local water supplies due to environmental regulations and prolonged drought. The municipal system, the nation’s largest, is also highly reliant on vulnerable water imports, including the Colorado River. The utility’s water bond was rated “AA+” and “Aa2” by Fitch and Moody’s, respectively, earlier this year.
- Atlanta’s Water and Sewer System received the second highest water risk score, a direct result of its reliance on one key local water supply whose future is jeopardized by a judicial order that may require the city to reduce its withdrawals by as much as 40 percent in 2012. The utility’s water bond received “A” and “A1” ratings from Fitch and Moody’s, respectively, earlier this year.
- The Phoenix and Glendale, AZ utilities—systems with high reliance on increasingly expensive and potentially volatile out-of-state water imports from the Colorado River—also received high water risks scores. The Phoenix bond is rated “AAA” and Glendale bond “AA” by Standard & Poor’s.
- Water risk scores for the Tarrant County, TX utility were double those of the neighboring Dallas system. The wide gap is the result of Tarrant County’s consistent drawdown on critical storage reservoirs to meet water demand, which makes the system more vulnerable to prolonged drought. Both utilities have identical credit ratings.
Among the key findings for the two electric utility bonds:
- Alabama’s PowerSouth Energy Cooperative, which provides power to 49 counties in rural Alabama and northwestern Florida, received the higher risk score, primarily due to the system’s potential vulnerability to increased water temperatures and lower flows in the Tombigbee River, the cooling water source for its largest coal-fired plant. The utility’s bond received “A-” ratings with stable outlooks from both Fitch and S&P last year.
- The Los Angeles electric power system‘s risks are driven in part by reductions in power generated at the Hoover Dam due to low water flows in the Colorado River Basin. The system may also see reduced power deliveries from one of its major coalfired power plants in Utah, due to heavy competition for dwindling cooling water flows. The utility’s bond received “AA” and “Aa3” ratings this year from Fitch and Moody’s.
The study shows that credit ratings agencies’ methodologies largely ignore water risk and may even unintentionally foster wasteful water consumption. Many credit ratings reward pricing and infrastructure plans that encourage increased water use and revenue growth with disregard for even near-term supply constraints and likely disruptions.
Ceres (pronounced “series”) is a national network of investors, environmental organizations and other public interest groups working with companies and investors to address sustainability challenges such as global climate change.






