Climate change threatens utility credit ratings

Water risks triggered by climate change and the depletion of groundwater reserves are having a largely negative impact on credit ratings, according to a new report.

Increasing water-related risks, including freshwater scarcity, flooding and droughts, played a significant role in the analysis by ratings agency S&P Global Ratings.

The report says water-intensive industries – including utilities and power – are unsurprisingly the most exposed to water factors.

Between July 2015 and August 2017, water factors were mentioned in 169 rating action articles and were the main driver of 28 rating actions. Of these rating actions, approximately 70 per cent were negative and around half represented downgrades.

S&P’s research focused on two main categories of water-related risks: event-driven and continuous factors. Examples of event-driven factors are droughts, heavy rain and floods, which have one-off impacts. Continuous factors relate to companies that are dependent on water and weather as a resource or service, which means that water represents an inherent risk or opportunity.

While continuous factors were present in more credit analyses (61 per cent of cases), event-driven factors were more likely to cause a rating action. There was a rating change in 24 per cent of the cases with event-driven factors, and within that figure only 17 per cent were positive.

“As climate change continues to fuel volatility in other weather systems and the hydrological cycle, we could see more rating actions caused by water-related events,” said Beth Burks, environment, social and governance analyst at S&P Global Ratings.

Where continuous factors were a key driver in a rating change, the result was split evenly between positive and negative actions.

In the report, S&P highlights its decision to downgrade Thames Water’s credit rating in July 2017. The firm’s rating on class A and class B debt was lowered to BBB+ and BBB-. “Our downgrade of Thames Water was the result of poor water management compared with peers related to leakage from below-ground water assets that resulted in financial penalties,” explained Burks.

According to the report, the company lagged peers’ operating performance in terms of customer service and below-ground water assets, resulting in regulatory penalties and fines at a time when the Thames Water financing group had no headroom for the rating with respect to its funds from operations to debt ratio.

S&P added that despite improvements to operating performance in several areas, Thames Water remained affected by the performance of its below-ground water assets, which led to the company failing its leakage target for 2017 and to several consumer interruptions.

But while water risks can have widely negative credit implications for utilities, they can also fuel growth for some businesses.

“As markets and issuers absorb the impacts of droughts, floods, and declining water quality, there are opportunities as well as challenges,” said Burks.

Businesses that offer water solutions, such as water treatment technologies, have experienced positive influences on credit.