Investors: Beware of hidden water risks

In yet another sign that there’s a risky disconnect between real environmental conditions and business perceptions, a new report warns that investors who buy municipal bonds in the US might not be getting the full picture on the water challenges facing public utilities.

“The Ripple Effect: Water Risk in the Municipal Bond Market,” a new report from the sustainability-focused organisation Ceres, finds that growing water scarcity is a hidden financial risk for investors buying bonds that help pay for much of the nation’s water and power infrastructure. The study concludes that some of the largest public utilities in the US face “moderate to severe water supply shortfalls” in the future that aren’t reflected in either prices or disclosures to investors.

In addition to their potential impact on the nation’s 50,000-some public water utilities, such shortfalls could also affect the water-intensive electric power sector. Generation of electricity in the US accounts for about 41 per cent of freshwater withdrawals.

“Water scarcity is a growing risk to many public utilities across the country and investors owning utility bonds don’t even know it,” said Mindy Lubber, president of Ceres. “Utilities rely on water to repay their bond debts. If water supplies run short, utility revenues potentially fall, which means less money to pay off their bonds. Our report makes clear that this risk scenario is a distinct possibility for utilities in water-stressed regions and bond investors should be aware of it.”

Among the regions Ceres identified as facing the most pressing threats were:

• The city of Atlanta, which could see its water supply cut by nearly 40 per cent as early as 2012 due to the ruling of a federal judge;
• The Southwest’s Lake Mead, which is quickly approaching a first-ever water shortage declaration that would reduce deliveries to fast-growing Arizona and Nevada;
• Another Southwest facility, Hoover Dam, which provides hydropower to major urban centers in California, Arizona and Nevada. If water levels in Lake Mead don’t start recovering, the dam could stop generating electricity as soon as 2013;
• The US Southeast, which can expect more regular droughts and heat waves that are likely to increase the operating costs of power generators. One company, the Tennessee Valley Authority, has already been forced to slash power generation for two weeks at three of its facilities in Alabama and Tennessee because of heightened water temperatures. The action cost the utility an estimated $10 million in lost power production.

The Ceres report models both water and electric utility water risk exposure by comparing available supplies with projected water demand up to 2030. The model uses stress scenarios that incorporate climate change impacts, regional water conflicts, water-saving regulatory actions and other potential external risks on water supplies.

The report concludes that current credit rating agencies’ methodologies could do more to address water scarcity risks and provides recommendations for utilities, investors, underwriters and credit rating agencies to manage emerging water risks in utility bonds.

“(T)oday these ratings take little account of utilities’ vulnerability to increased water competition, nor do they account for climate change, which in many areas is rendering utility assets obsolete,” the report states. “Consequently, investors are blindly placing bets on which utilities are positioned to manage these growing risks.”