MuniLand: California Drought Impact On Municipal Bonds

Severe drought in California and the Colorado River Basin is pressuring fresh water resources in the region.  A recent study by NASA and the University of California, Irvine, found that more than 75% of the water supply has been lost in the Colorado River Basin since 2004.  Low snow-pack levels and overuse of ground water is jeopardizing water supplies and hydroelectric power generation for some 40 million people in seven states and Mexico.  The drought conditions are impacting municipal water utility bonds in a positive way.   In times of drought, the pricing power of water utilities increases and benefits the credits via wider operating margins.  For instance, Bloomberg News reports farmers in the Central Valley of California are paying as much as ten times more for water than before the State initiated conservation measures.  On the flip side, the scarcity of water is constraining hydropower generating capacity and power grid reliability in California.  We have relatively little exposure to California hydropower credits, preferring strong Pacific Northwest hydropower and California renewable wind power credits.  Drought conditions in California are a credit positive for West/Intermountain non-hydro energy and renewable energy credits.  Year-to-date, the BofA Merrill Water index has outperformed the AAA Municipal index by about 2.5%.  The tertiary impact of the drought is a proposed $11 billion in new municipal bond supply coming to market with California’s Proposition 43 – Water Bond initiative.  The ballot initiative is on the November 2014 ballot and would be welcomed by the market, as higher tax rates and low supply of California debt have compressed yields across municipal issues in the state.  SNWAM will continue our fundamental research and link incongruent themes to generate outperformance, find value and protect principle in the municipal bond market.