Investors in public water and utility bonds need to demand more information about potential water scarcity problems that could affect their investments, warns Ceres, a national coalition of investors, environmental groups and public interest organizations working to address sustainability issues such as water shortages and climate change.

When judging the quality of the utilities' bonds, electric and water supply utilities and bond rating companies are not taking into consideration the effect water scarcity may have on the bonds and the utilities' ability to make payments on them, Ceres noted in its report The Ripple Effect: Water Risk in the Municipal Bond Market.

However, at least two ratings agency says they are considering such issues. "Water has been scarce in the West since the area was first settled, and Moody's has long incorporated a forward-looking analysis of the adequacy of water supplies into our ratings," says Eric Hoffmann, senior vice president and analyst, Moody's Regional Ratings. "Our credit ratings and accompanying research give investors a range of information about factors that can affect the relative probability of default of a water utility, including the overall financial profile of the issuer and the cost and availability of water supplies over the life of the security."

Standard & Poor's Ratings Services' credit analysis of water utilities includes an assessment of the utilities' current and future sources of water and explicitly addresses how water sufficiency and quality issues are likely to affect business and financial risk, says Ana Sandoval, Standard & Poor's communications manager.

"To date, none of these factors have impacted ratings because supplies are deemed to be sufficient to meet demand in the near to intermediate term and it is our opinion that these issuers will continue making timely debt payments," she says.

The Ceres report says some of the nation's largest public utilities may face moderate to severe water supply shortages in the near future, but the risks are not reflected in the pricing or disclosures about the utilities' bonds. The electric power sector uses 41% of the nation's freshwater, directly tying its operation to the availability of water.

Ceres studied municipal bonds for electric and water utilities in the water-stressed areas of Texas, southern California, Arizona, Alabama and Georgia. PricewaterhouseCoopers developed a model for measuring water stress and financial risks.

"Water scarcity is a growing risk to many public utilities across the country and investors owning utility bonds don't even know it," says Mindy Lubber, Ceres president. "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," she adds.

The study compared utilities in several regions and used a model to compare their standard bond ratings and their risks of water shortages. For example, Tarrant County, Texas, has twice the risk of water shortages than nearby Dallas, which also faces shortage problems. They are served by two different utility companies, but despite the risk differences, S&P and Moody's gives both utilities the same high ratings, AAA and Aa1, respectively.

The information the model used to determine the risks included public information on water supplies, project usage through 2030, stress scenarios and regional water conflicts.

The report concludes that current credit-rating agencies could do more to address water scarcity risks and to provide recommendations for investors, underwriters and credit rating agencies to manage emerging water risks in utility bonds.

Investors and their advisors should question large utilities about their sensitivity to water stress, ask their asset managers to assess the water risks, and request guidance from financial regulators about disclosures on water and climate risks, the report advises.

In addition, bond underwriters should help utilities disclose their sensitivity to water stress and their plans for mitigating risk, the report says.