February 10, 2019

Breakingviews: Market ignores Colorado river crisis at its peril

by Breakingviews.

The Colorado river crisis ought to be upsetting markets. The U.S. waterway supports some $4 trillion in GDP and at least $1.3 trillion in stock value across seven U.S. states. The river was already virtually tapped out last century, and continuing troubles have now led the federal government to step in to help manage its water use. Yet investors have barely caused a ripple.

The river’s average flow has dropped by a fifth since 2000 and is set to fall more, and screwy governance makes basin-wide planning hard. Matters would have become worse sooner, except the two main dammed storage areas, Lakes Mead and Powell, were full in 2000, and the four upper-basin states have not been tapping their full allocation. But the lower three have been overusing theirs.

As a result, the dams are now less than half full, with Lake Mead so low that the states have for the past few years been trying to agree so-called drought-contingency plans to reduce water use. The failure to get there means the U.S. Bureau of Reclamation’s commissioner, Brenda Burman, last Friday took direct control of planning.

The local economies may already be feeling it, but investors don’t seem to be scrutinizing companies that might be exposed. There are, for example, 38 S&P 500 Index companies worth some $1 trillion based in southern California and the six other watershed states – Colorado, New Mexico, Utah and Wyoming in the upper basin, and Arizona and Nevada joining the Golden State in the lower basin.

That may be partly because not enough companies disclose their water risks. Only two of them – Freeport-McMoRan and Sempra Energy – have outlined how a drier Colorado river could hit earnings in submissions to CDP, a nonprofit pushing for better environmental-risk disclosures on behalf of investors representing more than $110 trillion in assets.

In fact, only 11 public U.S. companies, worth $370 billion, handed over data, along with 13 private and overseas groups including Toyota Motor and Unilever.

The estimated impacts vary. Caesars Entertainment reckons it would cost up to $15 million to significantly reduce water use at four casinos in the region. Defense contractor Raytheon is worried it could lose up to 20 percent of its revenue. It’s not clear, though, whether even these more water-savvy companies have factored in the full extent of the problem.

The state laggards in providing their plans for dealing with the water shortage are Arizona and California. Burman, the USBR commissioner, said she will back off again if they catch up, and Arizona may be on track. But California’s Imperial Irrigation District won’t sign off unless it gets a $200 million federal grant to help protect an endangered area called the Salton Sea.

Burman also stressed that, if no agreement is struck, a 1963 Supreme Court decision gives her bureau wide latitude to change lower-basin water allocations.

Investors shouldn’t think that will be an easy fix, though. The best answer might be to cajole the region to curtail its agriculture sector, which accounts for up to 80 percent of water use. Animal feeds dominate and are thirsty crops; just improving irrigation for alfalfa would save 1 million acre-feet of water annually, according to the Pacific Institute, a water-research firm. That’s equal to roughly a third of what homes and businesses currently use each year.

But farmers own the lion’s share of the rights to the Colorado’s flow, and any attempt to change that is likely to face a long legal struggle. The Imperial Irrigation District may be at the end of the river, but it has the right to a fifth of its water. Shifting large amounts of water from agriculture to cities could in any event harm landscapes, potentially hitting property prices and tourism.

All the while, the dire situation will only get worse. Higher temperatures already account for half of the decline in flow over the past 19 years, according to research by Brad Udall of the Colorado Water Institute, and volume could fall by another third by 2050. Less water isn’t the only risk. Higher temperatures mean less snow and more rain, which will change how and when water flows and bring more floods. The river’s hydropower-generating capability may be seriously impaired.

Yet the lack of response from investors is deafening. Stock-price movements for regional S&P constituents and for CDP respondents show no sign of reacting to the ups and downs in river negotiations in 2018, an analysis by Breakingviews suggests. The topic didn’t even come up on Raytheon’s earnings calls, despite the company’s substantial stated exposure.

Shareholders don’t have influence over the seven affected states’ representatives. But they could push the companies they own in the region – and elsewhere – to investigate, understand and disclose their water risks. That’s the first step to developing a strategy to cope, and avoid a potentially painful hit to valuations.


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