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Growing Water Scarcity and Its 'Hidden' Risks to Investors

Water scarcity in several U.S. regions poses hidden financial risks to investors in municipal bonds -- the key mechanism for financing the country's water and power infrastructure, according to a study by Ceres and global equity investor Water Asset Management.

Their recently released report, "The Ripple Effect: Water Risk in the Municipal Bond Market," is the first to examine and rank water scarcity risks for public water and power utilities in some of the more water-stressed areas in the U.S. The report also details a unique tool, a model developed by PricewaterhouseCoopers, that is designed to help rating agencies, public utilities and investors understand the potential risks of an undersupply of water.

"If we've learned anything from the recent credit crisis and resulting economic downturn, it's to be concerned about hidden risks in assets owned by major investors across our economy," said Mindy Lubber, Ceres president and the director of the Investor Network on Climate Risk, in the forward to the report.  "Growing water scarcity in many regions of the United States is a risk running through municipal bond markets, one that must be addressed if we are to protect the strength of those investments and finance our nation's vast water and power infrastructure."

"This report by Ceres and Water Asset Management shows that few participants in the bond market -- including investors, bond rating agencies, and the utilities themselves -- are accounting for growing water scarcity, legal conflicts and other threats in their analyses," said Lubber, whose organization is a national coalition of investors, environmental groups and other public interest organizations that work with companies on sustainability challenges.

"Some are even inadvertently encouraging risk by rewarding pricing and infrastructure plans that encourage increased water use despite near-term supply constraints. By overlooking these critical factors, all involved are allowing water risk to grow -- and remain hidden -- in the bond market."

The potential risk is vast, according to the report. About 50,000 public water utilities serve an estimated 258 million people in the U.S., and the electric power sector accounts for 41 percent of the nation's freshwater withdrawals, the study said.

Using the risk assessment model, researchers looked at eight investment grade municipal bonds for water and electric power utilities in southern California, Arizona, Alabama, Georgia and Texas. The model, which uses publicly available information, compared the utilities' available supplies with projected water demand from 2011 to 2030, and generated water scarcity scores to reflect the utilities' relative risk of an undersupply of water over a 20-year period. The Los Angeles and Atlanta water utility systems received the highest risk scores, the report said.

The report emphasized that the water risk score is not an indicator of the likelihood of default, but said "by coupling the water risk scores with other financial information already available in credit rating opinions and bond documents, investors can gain a more complete picture of a bond's total risk profile."

In addition to detailing the modeling tool, the report offers recommendations on managing water risks in utility bonds to utilities, investors, underwriters and credit rating agencies.

The report is available for free download at http://www.ceres.org.

Image CC licensed by Flickr user sfxeric.

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