Local governments face challenge of rising water costs

Bonds

Issuers, if they’re not already doing so, will soon have to pay much more to supply water to their constituents, turning to ever more inventive ways of procuring and treating water as fresh water supplies run down.

That was the focus of one of the panels at the National Federation of Municipal Analysts’ 2023 Annual Conference Wednesday, where panelists detailed the complex landscape of how states and local governments provide water and the efforts they’re going through to combat a depleting fresh water source.

“The fresh water sources that we’ve all used, particularly for the municipal or industrial commercial use, is low hanging fruit because it’s the least cost to turn that raw water source into what needs to get through the system and to our uses,” said Brett Bovee, president and principal for WestWater Research. “We’ve plucked all the low hanging fruit and now we’re going to the other branches—it’s basically the dirty water,” he added. “It’s brackish, it’s the water that went down your sink, it’s sewer flows. These are the sources we’re turning to, treating them at higher costs.”

There is generally no federal solution to water treatment and it is typically a local government’s responsibility to provide the adequate amount of water to serve its residents. But since states and local governments have generally used up all the cheap fresh water, the next supply will be substantially more expensive.

“The affordability of water is a ticking time bomb and may be the thing that goes before the infrastructure and water supply fails,” said Erika Smull, municipal research analyst for Breckinridge Capital Advisors.

“That next incremental supply might be three, four times the cost of the supply you’re dealing with right now,” Bovee said. “That’s the challenge for the municipal sector in general.”

Panelists described the conditions for water as a difficult one, given that most people access water infrastructure on a daily basis but never see how and where the water is transported and stored, as well as the messy amalgam of state governments and local entities in control of it all. But as cities and local governments begin to search for alternative sources of water, they may have to get used to the fact that future water consumption will have to come from things like wastewater.

“Some people just don’t feel great about consuming water that once was wastewater and that’s the whole thing that I know a lot of cities are trying to contend with right now,” said Erika Smull, municipal research analyst for Breckinridge Capital Advisors. She said that we’ll increasingly see issuers have a more diverse range of water sources they draw from.

But for bond investors, the risks and hazards are even less clear. When asked by fellow panelists as to whether the various risks and hazards associated with water are priced into municipal bonds, Smull said she doesn’t think so, given the enormous downside risks such as changes in supply, emerging contaminants and federal mandates which localities have to meet.

“I don’t really fault the water utilities, they’ve basically been dealt an extremely difficult hand,” Smull said. 

There are 52,000 community water systems in the U.S. and about 70% of them access the municipal bond market. But in order to meet many of the federal mandates on drinking water, local governments have to pay a considerable amount of money, Smull said, and a lot of that is coming from bond proceeds and not the federal government.

There are still many water utilities and local governments who’ve stayed ahead of emerging issues and continue with a lot of cash on hand and strong credit ratings. As governments begin to pay more for the same water, affordability will be the next focus.

“The affordability of water is a ticking time bomb and may be the thing that goes before the infrastructure and water supply fails,” Smull said.

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