October 21, 2010 / 11:06 AM / 9 years ago

Water risks hide in U.S. utility bond market -report

* Global warming making water risks greater for utilities

* Credit ratings agencies underestimate or ignore risks

By Timothy Gardner

WASHINGTON, Oct 21 (Reuters) - Many investors are oblivious to growing water scarcity in the U.S. West and Southeast that pose risks to municipal bonds issued by water and power utilities, according to a report issued on Thursday.

“If water supplies run short, utility revenues fall, which means less money to pay off their bonds,” said Mindy Lubber, president of Ceres, a Boston-based coalition of investors and environmentalists, which produced the report with PricewaterhouseCoopers, and Water Asset Management, a global equity investor.

“This risk scenario is a distinct possibility for utilities in water-stressed regions and bond investors should be worried about it,” said Lubber.

The groups said the report, called “The Ripple Effect: Water Risk in the Municipal Bond Market,” is the first study of the impact of water scarcity and climate change on municipal bonds issued by utilities.

Institutional investors like pension funds have been flocking to municipal bonds recently because of benefits that often include tax-free interest and higher yields.

But such water and power utilities should be disclosing the risks to such bonds to the investors, investors need to learn more about the risks, and credit rating agencies need to consider the risks in their ratings, the report said.

Scientists have said that climate change will increase the risk of more droughts in the U.S. West and other places in the country.

A study by the U.S. National Center for Atmospheric Research released on Tuesday projected that the impact of serious droughts could be felt in the western U.S. by the next few decades, and that the impact by the end of the century could go beyond anything in the historical record. [ID:nN19122453]

INTERVENTIONS

“This is not about an immediate tomorrow morning threat,” said Jon Williams, a partner with PwC in London, who developed the modeling for the report, said in an interview.

“This is about raising the issues in time for utilities to make interventions to reduce the risks and for investors to be informed as to how that risk management is happening.”

Profits at power utilities that rely on hydropower can be hurt by droughts when water levels fall. In addition, utilities that use water to cool their coal and nuclear plants can suffer when temperatures in rivers rise above levels that they are allowed to continue that practice.

The power sector accounts for 41 percent of the nation’s freshwater withdrawals, the report said.

The report modeled six water utilities and found that the Los Angeles Department of Water and Power, or LADWP, received the highest risk score due to restrictions in local water supplies and the system’s dependence on water imports to satisfy demand.

Despite such risks that the report claims, the utility’s water bond was rated “AA+” and “Aa2” by Fitch and Moody’s, respectively, earlier this year.

The LADWP said the Ceres report was “uninformed and miscalculated,” in part because it did not acknowledge water consumption reductions among its customers for the past three years.

Of the two electric utilities modeled in the report, Alabama-based PowerSouth Energy Cooperative got a higher risk score than the LADWP, due in part to increased water temperatures on a river which is the cooling water source for its largest coal-fired plant.

PowerSouth could not be immediately reached. Its bond received “A” ratings from both Fitch and S&P last year.

The full report can be seen at www.ceres.org. (Reporting by Timothy Gardner; editing by Carol Bishopric)

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