California has endured four years of severe drought, raising fears of economic hardship and reduced revenues at water authorities. We don’t think the state will run out of water—or money to pay its debts.
Despite the drought, California’s economy has grown more rapidly than the US economy in each of the last three years. Even after several years of water challenges, the drought’s economic impact at the state level has been minimal.
California Continues to Make Economic Gains
But scarcity is causing change. Farmers, who use 80% of the state’s water, have been forced to dig deeper wells or to leave fields unused, idling farm workers. Investors need to understand the impact: agriculture is only 2% of the state’s gross domestic product (GDP) and 3%–4% of total jobs.1 And economic gains in sectors such as construction, trade, and professional and business services have more than offset losses related to agriculture.
In 2014, California’s GDP grew by 4.5%, versus 3.9% in the US. Its job growth was 3%, compared to less than 2% nationally. The state’s 2014 GDP growth was pared by just 0.1% due to the drought, with a similar reduction expected for 2015.2
Even California’s five largest agricultural counties (by crop value)—Fresno, Kern, Tulare, Monterey and Merced—have all posted consistent job growth. May 2015 data show that job growth in the Fresno metro area is faster than the state’s or the national average, led by jobs in trade and professional and business services.
Conservation Won’t Lead to Defaults
But many water districts have issued substantial debt over the last decade, particularly the Los Angeles Department of Water and Power, the San Francisco Public Utilities Commission and the San Diego County Water Authority. The money was used sensibly—mainly to rebuild aging infrastructure and diversify the water supply. But here’s the big question: can authorities reduce state water consumption by 25%, as recently mandated, essentially selling less—while still maintaining strong finances?
Water conservation could mean consumer water bills drop and revenues fall, which might lead to less cash flow available to meet annual interest and principal payments on debt. But California’s major water authorities have excellent ratings, generally AA. The Los Angeles Department of Water and Power’s water revenue bonds are a great example. The city reported that 2014 pledged net revenues were more than double what it owed. So even if ratings drop a notch, water authorities aren’t in danger.
Controlling Demand Through Conservation
Water authorities also have flexibility with rates. They’re a monopoly provider of an essential service, which gives them the ability to increase rates to raise revenues. Many authorities are also using price rationing: heavy users pay higher rates, which encourages conservation while preserving profits (although a recent court decision has added complications to this practice).
Water conservation is a driving force for California water authorities; they’ve persuaded customers to install high-efficiency appliances and focus on desert-friendly plants. Over the last 10 years, San Francisco’s water consumption has dropped 17%, despite a 4% population increase. San Diego and other jurisdictions have also been innovative in encouraging water recycling and storage to curtail demand. By continuing to adapt, water authorities should stay financially stable.
San Diego County Innovates to Increase Supply
Water flows north to south in California, and since San Diego’s at the end of the line, scarcity’s always been a concern. The county highlights how California authorities are responding positively to water shortfalls.
In 1991, the San Diego region got most of its water from one supplier, the Metropolitan Water District of Southern California (MWD), making it vulnerable to shortages. By 2014, San Diego had diversified its supply and reduced reliance on the MWD from 95% to 49% (Display).
Its biggest move was investing $1 billion in a desalination plant and pipeline in the city of Carlsbad; when completed later this year, the project will provide 7% of San Diego County’s water, or 50 million gallons a day. San Diego’s example has inspired discussions about building desalinization plants in Huntington Beach and the Bay Area and restarting a plant in Los Angeles.
California Will Come Up with Answers
What if the drought is permanent? The Sierra Nevada snowpack is an essential source of water in the summer as it melts, but it’s at record lows. If drought is part of a long-term weather trend, this could become chronic, and more severe conditions could increase economic pressures. Eventually, more spending on water solutions could affect the state economy.
California is facing a big challenge, but we’re convinced it can devise cutting-edge solutions. We think its water agencies’ finances are generally solid, and restrictions are unlikely to hurt the credit quality of those utilities’ revenue bonds in the short term. And we don’t see the drought impacting the credit quality of the state’s or most cities’ general obligation bonds.
California won’t run out of water—it just needs to balance water supply and demand.
1. Richard Howitt et al., Economic Analysis of the 2014 Drought for California Agriculture (Davis, CA: Center for Watershed Sciences, University of California, Davis, 2014).
2. Jason Sisney and Justin Garosi, “Limited Statewide Economic Impact of Drought,” Legislative Analyst’s Office (April 14, 2015). http://www.lao.ca.gov/LAOEconTax/Article/Detail/86.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.