California water credits face pressure from accelerating operating risks

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Some California water and sewer utilities could face financial challenges as they increase spending to deal with supply reliability and regulatory requirements, Fitch Ratings said.

Many California water agencies have already raised rates to offset drought-related demand reductions pushing them close to or above Fitch’s affordability threshold, according to the rating agency’s special report released Tuesday.

“Water utilities may face increasing pushback and decreasing rate flexibility going forward, which could impact how well utilities are able to manage their finances,” said Shannon Groff, a Fitch director and lead author of the report.

The challenges with the Delta tunnels project that would convey water to Central Valley farmland and southern California cities from the Bay Area underscores the issues with water volatility for the state’s southland, Groff said.

If the Water Fix project does move forward the credit concerns will center on cost recovery, the potential for cost escalation during construction and resulting leverage, according to the report.

It also appeared the project would be downsized from the original two-tunnel project to one tunnel as recently as last week when the Metropolitan Water District of Southern California swerved back to supporting a two-tunnel scenario. The project also has faced opposition from environmental groups, as well as some water agencies concerned about cost issues.

The Westlands Water District board, which serves Fresno and King counties, voted not to contribute money.

The Metropolitan Water District of Southern California voted to provide $10.8 billion of the $16.7 billion cost of the two-tunnel project, but that vote has raised opposition from the water agencies the wholesaler serves over potential rate increases.

MWD’s vote adds a “big boost,” but there are still hurdles to overcome, Fitch analysts wrote.

Currently, the majority of water and sewer agencies rated by Fitch have strong credit profiles and an overall average rating of AA and that isn’t expected to change as most utilities have sufficient capacity to manage through the operating risks and maintain credit quality.

While most water agencies are posed to handle the challenges, Fitch analysts wrote, they have “seen notable variability in the financial performance of Fitch-rated utilities during the drought years.”

Credit quality could be at risk for utilities that are unable to raise rates if consumption continues to decline as operating costs increase.

These instances are expected to be rare given the historic fiscal prudence of California utilities even when presented with operating challenges, Groff said.

“Water supply projects will vary significantly based on geography, with Southern California facing the most volatility and requiring the largest investment,” according to the report.

Voluntary and later mandatory conservation efforts had the greatest impact on utility finances as deep declines in demand occurred in 2015 and 2016.

The state implemented voluntary conservation targets of 20% in 2014, but stair-stepped that up to a requirement that utilities cut water usage by 36% from June 2015. That mandate ended in February 2016, but Gov. Jerry Brown issued an executive order directing the state agencies to establish a long-range plan incorporating conservation and drought planning.

Five California state agencies released “Making Water Conservation a California Way of Life,” in April 2017, a report that outlines permanent conservation regulations with water use targets to hit by 2025. The proposal was incorporated in Assembly Bill 1668 and Senate Bill 606, which were held over to 2018 from the 2017 legislative session.

Nationally, water and sewer utilities benefit from a monopolistic business structure and rate setting authority that helps to insulate these utilities through business and economic cycles; and the same is true for California, analysts wrote.

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Utilities Infrastructure Bond ratings California Department of Water Resources The Metropolitan Water District of Southern California California