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The Financial Side of Water (and of the lack thereof)

November 7, 2010

The Atlanta water crisis figures prominently into a stunning new report highlighting the “hidden risk” that water scarcity creates in the municipal bond market, carrying implications not just for Wall Street investors but for, well, anybody who makes use of a public water system. (And that’s a lot of us.)

Drawing a parallel to the previously unseen risks in real estate investing that rocked financial markets so severely beginning in 2008, the report argues convincingly that everyone involved in managing and financing water and electric utilities, from the utilities themselves to investors and credit rating agencies, would do well to factor water supply instability into their plans for the future.

What’s the big deal? Take the example of a municipal water utility, perhaps the county water department that supplies you with water wherever you live. In order to be able to provide your drinking water and treat your wastewater, the utility has to build and maintain some serious physical infrastructure – pumps, pipelines, treatment plants, reservoirs, and so on – which incurs significant costs. Those costs are usually fronted by investors who’ve purchased bonds from the utility on the bond market; the utility pays those investors back, over time, mainly with revenue generated from water sales and wastewater surcharges — i.e., your water bill.

As with any venture or any borrower, there’s always some chance that the utility might encounter financial difficulties that will make it unable to repay its debts. Fortunately, that’s rare. And just as with a home foreclosure, such a “default” ultimately benefits neither the borrower, the lender, nor the system as a whole. It’s the job of the credit rating agencies, meanwhile, to assess that chance (based on a disclosure by the utility) before investors jump in.

“Today,” says a report titled The Ripple Effect: Water Risk in the Municipal Bond Market, “most public utility disclosures and credit ratings apply the faulty assumption that future water availability will resemble the past.” In reality, water scarcity and related problems could become major concerns in many areas of the country. Hence, it says, those investors “may be exposed to water risks obscured by credit ratings and utility disclosures that devote inadequate attention to these issues.”

The report comes from Ceres, which describes itself as “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.” It examines Atlanta’s water-supply instability in the wake of the Magnuson ruling as one of eight case studies of utilities across the country. And it appears to derive some of its very raison d’etre from the fact that Moody’s Investor Services affirmed the City of Atlanta water system’s stable, healthy credit rating for $3.24 billion in debt, despite the Magnuson ruling and the regional context of water-supply conflicts and constraints that brought the ruling about.

But more important, the Ceres report points out that to be ready for the future in many (if not most) regions of the country, all parties to utility financing need to incorporate into their models a realistic view of future water quantity and quality concerns – whether from drought, supply competition or other factors including climate change and that good ol’ water-energy nexus.

It’s worth noting that the report delves deeply into the intertwined relationship between water quantity and electric power generation, even including two electric utilities (not just water utilities) among its eight case studies, and referencing the Tennessee River hot-water issue that you may have read about on this blog a couple of months ago (see above link).

Also important: The report is not just a warning flag for investors, to the detriment of utilities. Rather, it makes detailed recommendations to all the players on this scene, warning that utilities which fail to factor for water scarcity “may find themselves in a vicious cycle of credit stress as they face constraints on water supply.”

For both water and power utilities, those recommendations focus heavily on managing and reducing demand. (Skip to page 70 of the PDF to see them.) In fact, the water recommendations look an awful lot like the conservation and efficiency measures that Georgia conservationists have been promoting for our home state, along with a push for green infrastructure to boot.

Read Ceres’ own press release and download the report here. It caught coverage in the New York Times business pages and from Reuters via SolveClimate News, and could stand to receive attention here in Georgia for sure.

-Ben Emanuel

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4 Comments leave one →
  1. DrinkMoreWater permalink
    November 8, 2010 7:51 pm

    Any chance of the Ceres report being taken seriously is undercut by the lack of objectivity (i.e. not “agenda” driven) as demonstrated by Ceres involvement with

    George Soros:
    http://www.google.com/search?q=site:www.ceres.org+soros&sourceid=navclient-ff&rlz=1B3GGLL_enUS373US374&ie=UTF-8&hl

    and Al Gore:
    http://www.google.com/search?q=site:www.ceres.org+gore&sourceid=navclient-ff&rlz=1B3GGLL_enUS373US374&ie=UTF-8&hl=

  2. garivernetwork permalink*
    November 9, 2010 2:23 pm

    I suppose I see your point, DrinkMore, but do you disagree with the report’s conclusion that strains on water supply could affect the financing of water infrastructure?

  3. DrinkMoreWater permalink
    November 10, 2010 7:08 am

    Of course any strains on a supply needed for an entity to function could affect its financial health.

    When the entity provides water, a basic need of human life and safety, then it only makes only even more sense to proceed very cautiously in actions that would strain the supply. These actions include opposition to needed reservoirs and implementation of unneeded conservation actions.

    When utilities borrow money in the market their financial health is looked at by rating agencies such as Moody’s and Standard and Poor. These agencies do look at water supply availability. The Ceres report is unfortunately biased by an unsound environmental agenda.

    • garivernetwork permalink*
      November 10, 2010 4:26 pm

      I’m not sure the Ceres report argues that the rating agencies do not look at water supply availability: its prevailing line is that they may not be looking enough at the future picture of water supply availability, which may be variable, rather than looking just at historical patterns.

      (That’s, I think, partly why the report looks at constraints on water supply that are new or might change [or continue to change] with future conditions — such as drought in Texas, snowpack melt in the far West, and the Magnuson ruling in Atlanta. I guess I’d also argue that these constraints are external to utilities’ actions in a way that your examples — “needed reservoirs and unneeded conservation actions” — are not. )

      In addition, I don’t think the Ceres report is out to get utilities. Its message, taken to heart, implies a fairly long view — over a time span, perhaps, in which these potential problems can be remedied — and, more important, is aimed at financial sustainability for all in the wake of other credit crises that have damaged the nation.

      Thanks for the comments. It’s definitely a complicated picture and worth hashing out.

      -Ben

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