Ongoing Debate Regarding Financial Risk Associated with Water Shortages

Water availability is a concern that is not new to water utilities, especially in certain parts of the country. The Natural Resources Defense Council (NRDC) recently reported that more than 1,100 counties in the United States will face high risks of water shortages by mid-century and more than 400 of the counties will be at extremely high risk for water shortages. As a new twist to water availability concerns, a report published in October 2010 by Ceres, a national coalition of investors, environmental groups, and other public interest organizations, concludes that such potential shortages demand a financial risk assessment when it comes to bond ratings.  The Ceres report surmises that the current financial risk assessment tools do not account for important pitfalls – such as water scarcity or the potential for, in the most drastic cases, simply running out of water.  Both of such risk factors may potentially force public water systems to purchase additional water at a higher cost, thereby creating a drain on the revenue potential for bond repayment.

The NRDC conducted a water shortage risk assessment nationwide, reflected in the graphic below.  Every state in the country is impacted by some level of water shortage risk, with some areas of the country being assessed as having “extreme” categorization.  This report finds that 14 states – Arizona, Arkansas, California, Colorado, Florida, Idaho, Kansas, Mississippi, Montana, Nebraska, Nevada, New Mexico, Oklahoma, and Texas – have extreme or high risk to water sustainability or are likely to see limited water availability as demand exceeds supply by 2050.


The Ceres report, titled “The Ripple Effect: Water Risk in the Municipal Bond Market,” provides analysis on how water scarcity could impact the municipal bond market. The study was conducted in conjunction with Water Asset Management, a water-related business investor and a unit of PricewaterhouseCoopers (PwC) that developed the model used in the study. The study suggests that water scarcity could be a significant risk in water utility assets for municipal bond investors because water scarcity is not calculated into the utility’s credit rating when issuing bonds.

PwC has developed a model to assign water risk scores to a utility for investors and credit rating agencies to use to assess a bond’s risk profile. Entitled “Water Evaluation and Assessment Project,” the model compares projected water flows from water sources and the utility’s demand under four different climate change scenarios, including wet and dry weather, along with other stress scenarios (drought, water rights, and regulatory actions for protecting wildlife) that would constrict water supplies.

The Ceres study profiled eight utilities including six water utilities and two power utilities in California, Arizona, Alabama, Georgia, and Texas in regions that are highly likely to have water shortages in the next 15 years. A water risk score was calculated for each utility based on the scarcity of water in that region and, when combined with the projected debt ratio, represented the risk associated with each utility. The study suggested that a utility with a high water risk score and a low debt capacity would likely have more difficulty managing debt than a utility with a similar water risk score with a high debt capacity. The study also took into account the ranking of rates. It was noted that a utility with a high water risk score and lower rates may be able to manage more debt than a utility with a high water risk score and higher rates, because the utility with lower rates may be more inclined to raise rates.

The Ceres group documented the risk associated with the Los Angeles Department of Water and Power (LADWP), which scored the worst of the eight utilities specifically analyzed by Ceres.  In response, the LADWP contends that the Ceres study did not account for recent City efforts to mitigate projected shortages.  However, this system purchased 72 percent of its water supply in FY2009, up from 33 percent in 2006.

The water supply and risk analysis issue has received and will continue to receive more attention as time goes by. It appears the issue may exacerbate existing challenges faced by systems to replace and/or reinvest in aging infrastructure. In 2009, the American Society of Civil Engineers (ASCE) again gave US drinking water system infrastructure a grade of D-minus. The ASCE estimates required public investment in drinking water infrastructure at $255 billion over the next five years. The Securities and Exchange Commission instituted more stringent rules for “events” and material risks municipal borrowers must disclose to investors.  The legal interpretive guidance is still being massaged, and the full impact this may have on bond ratings for municipal financing for water infrastructure is still yet to be seen.

The Ceres study provides a number of recommendations to utilities, bond underwriters, rating agencies, and investors, including disclosing water risk and mitigating risk.  It is not clear at this time what level of demonstrated risk reduction, if any, may be required by bond agencies in the future. It would be prudent, however, for systems to consider documenting any efforts related to water supply planning and conservation, and continue to be vigilant in preparations for alternate water supplies.


“The Ripple Effect:  Water Risk in the Municipal Bond Market,” Ceres, October 2010
“One-Third of US Counties Face Water Shortages.”  Opflow.  American Water Works Association, October 2010
“Climate Change, Water, Risk: Current Water Demands Not Sustainable,”  Water Facts.  Natural Resources Defense Council.  July 2010.
“Raters Skirting Water Hazards, Report Says,” Bond Buyer.  October 22, 2010.