Utility Week

UTILITY WEEK | 7TH - 13TH DECEMBER 2018 | 15 Finance & Investment Market view Turning the tide on credit quality Beth Burks examines the factors that affect the volatility of water company credit ratings. research shows that between July 2015 and August 2017, water risk – which encom- passes water stress (the ratio of demand to annual renewable supply), water quality, and weather events – was a contributing fac- tor in 169 rating actions and the main driver of 28 rating actions. Of these rating actions, approximately 70 per cent were negative, while approximately half represented down- grades (see chart). The most frequently cited factors or driv- ers in a rating update were insufficient water or precipitation, followed by excess water or precipitation, and water pollution or leakage. Who's at risk? Understandably, the most negatively affected are companies in water-intensive industries, such as power, mining, and agriculture, as well as industries in which weather patterns can influence consumer behaviour, such as leisure, sports, and retail. Electric and water utilities featured fre- quently in our analysis. In 2017, we down- graded Thames Water due to its poor water management compared with its peers. This followed leakage from some of Thames Waters' below-ground water assets – an inci- dent that led to financial penalties. In the same year, a severe drought in São Paulo, Brazil, resulted in negative rating actions for water and waste utility company SABESP, and for electric utility Companhia Energética de São Paulo, which operates hydropower plants. Opportunity from risk That said, evidence shows that water risks are not always negative for credit, with nearly 30 per cent of related rating actions having a positive impact (see chart). As markets and issuers absorb the impacts of droughts, floods and declining water quality, opportunities can present themselves. This is most apparent when issu- ers offer up water solutions, such as water treatment technologies in response to height- ened risks. Indeed, in the case of Companhia Energética de São Paulo, we took positive rating actions aer hydrological conditions became more favourable. In 2016 in Europe, and aer several years of drought, Croatia-based utility Hrvatska Elektroprivreda was upgraded based on evi- dence of improved liquidity. The upgrade reflected more favourable hydrological con- ditions and commodity prices over the prior two years. In addition, our affirmation of the ratings on SPCM (parent company of the France- based chemicals company SNF) cites the company's exposure to both municipal and industrial water treatment end-markets as supportive of its resilience to GDP cyclicality. Elsewhere, China's increased focus on environmental protection led us to revise outlooks to "positive" for China Three Gorges in November 2015. The company was respon- sible for construction of the Three Gorges Dam project, the world's largest hydroelectric plant, which became operational in 2008. As climate change continues to fuel vola- tility in weather systems and exacerbates the global shortfall of water supply, we could see a growing pool of water-related risks and opportunities. And importantly, as climate change intensifies, it is likely we could see more rating actions caused by water-related events. Beth Burks, ESG analyst, S&P Global Ratings RATING ACTIONS RELATED TO WATER FACTORS Source: S&P Global ratings 0 1 2 3 4 5 6 Number of references Most frequently cited category where water factors were a key driver in a rating change Regulated utilities Unregulated power and gas Power project financings Metals and mining upstream Branded nondurables Agribusiness and commodity foods Business and consumer services Leisure and sports Regulated and unregulated power and gas Road, bridge and tunnel project financings Building materials Oil and gas exploration and production Inherent weather risk Insufficient water or precipitation Inherent water risk Excess water or precipitation Mild weather Water pollution or leakage Weather delaying planting season Favourable hydrology conditions Sector C limate change is increasing both the frequency and ferocity of erratic weather conditions, such as flooding and droughts. As the stress on an already diminishing supply of groundwater reserves intensifies so too does the global supply- demand imbalance. And this pressure is nothing new. In fact, almost a decade ago, the World Bank estimated that the global water deficit worldwide could hit 40 per cent by 2030. Rating actions This is particularly concerning for water- intensive industries. The risks for companies are broad in scope and, importantly, can have both direct and indirect consequences for credit quality. And these results can be significant. Our

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