The Climate Report - Winter 2011
The perceived need for credit agencies to incorporate climate
risk into credit ratings was further reflected in an October 2010
joint report by Ceres, an investor advocacy group, and Water Asset
Management, a global equity investor in public and private
water-related companies and assets, entitled "
The Ripple Effect: Water Risk in the Municipal Bond
Market." The report concludes that growing water
scarcity in many regions of the United States, allegedly due to
long-term climatic changes, persistent drought, and other factors,
is an underreported risk running through municipal bond
markets.
The report states that more than 80 percent of the United
States' residential and industrial consumers rely on public
water utilities that collectively issue billions of dollars of
bonds each year to fund infrastructure for continued water
delivery. Similarly, public power utilities have a smaller but
significant portion of the nation's power grid, delivering
electricity to 45 million people. The power sector is extremely
water-intensive and reportedly accounts for 41 percent of the
nation's freshwater withdrawals.
To assess water risks, the report includes a qualitative model,
developed by PricewaterhouseCoopers LLP, to evaluate utilities'
water scarcity risk exposure by comparing available supplies with
projected water demand for the next 20 years. After applying the
model to eight investment-grade public utility bonds, the report
concludes that credit ratings of municipal bonds failed to take
into account the utilities' vulnerability to water
scarcity.
For example, the Ceres report asserts that credit rating agencies
failed to account for the Los Angeles Department of Water &
Power's high water risk due to environmental regulations,
prolonged drought, and reliance on vulnerable water supplies, such
as the Colorado River. In addition, the report concludes that
rating agencies ignored water risk in municipal bonds for
Atlanta's Water & Sewer System arising from reliance on one
key water supply, whose future is jeopardized by a judicial order
that may require the city to dramatically reduce its withdrawals by
as much as 40 percent in 2012.
After determining that credit rating methodologies reward utility
pricing and infrastructure plans that encourage increased water use
and revenue growth while allegedly disregarding water scarcity
issues, Ceres recommends that credit rating agencies employ water
risk "stress tests" in water utility ratings, factor
water intensity into ratings for electric utilities, and award
higher ratings to utilities that manage water demand through
pricing incentives in anticipation of future supply constraints.
Ceres further recommends that utilities provide more robust
disclosure of water risks for climatic changes, persistent drought,
legal conflicts, and environmental regulation, and recommends that
investors demand increased disclosure of these risks.
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