October 22, 2010

Warning for Utility Bond Investors: Water Scarcity a ‘Hidden’ Risk

Study says shortages affect water and electric utility bonds

Investors who buy bonds financing water and electric utilities may be taking on risks they haven’t bargained for, according to a new report released Friday by Ceres and Water Asset Management.

The Ripple Effect: Water Risk in the Municipal Bond Marketlooks at water scarcity factors in regions of the U.S. where water has been an issue of concern, and where large populations and/or farming put heavy demands on the supply. Such cities as Atlanta, Los Angeles, Phoenix, and Dallas have experienced water shortages that have led to regional conflicts and stricter regulatory controls. These shortages also put pressure on the utilities that depend on water: not just the 50,000 or so public water utilities, but also electric utilities, which account for, according to the Ceres release, 41% of the nation's freshwater withdrawals.

Mindy Lubber, president of Ceres, which authored the report, said in a statement, "Water scarcity is a growing risk to many public utilities across the country and investors owning utility bonds don't even know it. 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."

The report includes a model that assesses risk to both water and electric utilities, using publicly available information. Stress scenarios pit available supply against projected demand through 2030, factoring in additional stresses such as climate change impacts, regional water conflicts, water-saving regulatory actions and other potential external risks on water supplies.

Eight existing bonds from areas with water problems were examined for risk. Southern California, Arizona, Texas, and Alabama issues were evaluated against water scarcity, with Los Angeles and Atlanta water utilities coming with the highest risk scores.

Current rating systems do not adequately or consistently account for water risk, according to the report, and this leaves investors without a true idea of the exposure entailed in such investments.

Lubber added, "The model findings show markedly different water scarcity risks across the different bonds. This will provide investors and ratings agencies with further insight into water risks and encourage utilities to disclosure more fully how they are managing them."

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