Colorado River cuts could increase Arizona utilities' costs — and affect their credit ratings

The seven Colorado River basin states have less than a week until a deadline to put forward a plan for how to divide up water in the over-allocated river. And the ongoing negotiations — and lack of a resolution — have impacts beyond those states and their residents who rely on the water.

Water utilities are being mindful of their credit ratings — they help determine the interest rates they get when they borrow money to build new projects or pay for other needs. Fitch Ratings has a portfolio of water and sewer utilities nationwide, including in Arizona. According to a recent report, cuts to the Colorado River could increase those utilities’ costs.

Shannon Groff is a director at Fitch in the U.S. Public Finance Group in the Water and Sewer Sector — she focuses on the Western region, and rates utilities like the Central Arizona Water Conservation District, Tucson Water, Glendale Water and Gilbert Water.

She joined The Show to talk more about this.

Full conversation

MARK BRODIE: Shannon, what is the relationship between what's happening on the Colorado River and what a water utility's credit rating might be?

SHANNON GROFF: Absolutely. Well, the main purpose of water and wastewater utilities, particularly water, is the provision of water to their customers. So in that capacity, we rate the kind of under underlying financial health of these water districts and water utilities. And in order to do that, we're looking at supply, and we're looking at the cost of supply and whether or not what they're charging to their customers is keeping up with those costs in order to maintain financial margins and in order to maintain their leverage.

In this case, because, Colorado River, it has been in drought for about at least 20 years. Their supply has gone down by about 20% over the past 25 years. It is more difficult for these utilities to provide water, so they've had to look elsewhere for water supplies.

So not only is the cost of the Colorado River water increasing, but these utilities also have to look outside of that to start developing alternate water supplies, which means increased capital costs and increased operating costs. And those costs eventually need to be passed on to their customers, which could also eventually impact the affordability of water rates.

BRODIE: Does it get factored into a water utility's credit rating that this is sort of happening across the board? Like it's not just, you know, the Central Arizona Water Conservation District that's dealing with this, like pretty much anybody who deals with Colorado River water is also dealing with this.

GROFF: Absolutely, yes. We have many water districts in Southern California that are also dealing with this issue. And for many years, California water utilities have looked elsewhere to begin developing alternate water supplies.

BRODIE: So how does that factor into the credit rating? Because, you know, you referenced the, you know, the utility in San Diego, there are places obviously in Arizona that are looking at developing new sources of water, be it desalination or, you know, reclaimed wastewater, things like that.

Capital costs, in some cases, some pretty big time capital costs, which I would imagine are maybe a knock against those utilities, but then in theory, if they work out bringing in some amount of new water, which I would think would be a good thing for those utilities.

GROFF: Absolutely. That is something that water utilities are constantly balancing, is ensuring that they have enough water supply to meet demands now and in the future, but also ensuring that they are able to afford these very large scale, in some cases, capital projects.

So these are long term, typically projects that they will have to build into their rate base over time. And so we're looking at the financial margins there. Are they able to increase rates in line with their capital plans and their operating costs to meet that water demand?

BRODIE: And I would think that part of that balance would also be making sure that their credit rating stays high enough where if they need to borrow money to, you know, to do some of those capital projects, they're not paying more than they would otherwise in interest because their credit rating is lower.

GROFF: That is something that I'm sure that they are looking at. Most of our ratings are in the AA category. And in fact, across the country, our average rating is AA+, which is a very high rating. So our water and wastewater utilities have very highly rated and stable ratings. So that does help them in, you know, issuing debt and meeting these needs.

BRODIE: How closely are you watching the negotiations going on between the states over what to do with the Colorado River and the possibility that the federal government, you know, might have to get more involved and maybe even impose its own new set of rules?

GROFF: We've been watching the negotiations very closely for the past several years. As you probably know, the states missed the November deadline in order to come up with an agreement and now have a Feb.14, Valentine's Day deadline in order to put forth some kind of consensus proposal.

That said, we see all of these agencies already looking forward and realizing that they are going to have to cut something in order to maintain the Colorado River going forward. So they are already investing in these longer term capital projects in order to ensure that whatever cuts they do have to absorb, they will be able to backfill.

BRODIE: So is that to say then that assuming there are cuts to water, especially in the Lower Basin places like Arizona, that that doesn't necessarily mean a lowering of a credit rating for a water utility here?

GROFF: That's right. Water utilities are extremely forward looking. They have very long term planning horizons. And so most of them have seen that this is coming and have been planning for cuts and developing alternate water supplies. So some of this is already built into their operating structures and our ratings.

We just don't know the scale yet of what cuts are going to be required and what kind of additional supplies will be needed. But as I said, a lot of them are already planning for that and building it into their business models.

BRODIE: Right. Well, and it sounds like as you're saying, planning is kind of the key here. That, like if you are sort of building that into your operations, that seems from your perspective better than having something sprung on you kind of at the last minute and having to scramble and maybe raise rates or raise taxes if you're that kind of entity to make up the difference.

GROFF: Yes, we, we don't see any near term credit impacts to these water utilities. What we're looking at is more intermediate to longer term impacts and that is because they will need to raise rates and they will need to likely increase taxes if they have that tool. So over the intermediate to longer term, those increases could eventually pressure margins. They could eventually lead to pressure on the rate affordability.