Moody's sees 'red flag' water stress ahead for Phoenix area

A branch of the influential Moody's firm has come out with a dire, much disputed warning for commercial real estate leaders about the Phoenix area's long-term water supply.

It's in stark contrast to the mostly upbeat reactions of water officials, business leaders and some researchers this month after Arizona stopped approving groundwater use for new subdivisions across parts of greater Phoenix.

Led by Democratic Gov. Katie Hobbs, they took pains to say Arizona isn't running out of water. They said housing development will continue in virtually all existing Phoenix-area cities.

Even areas most affected by the decision won't see growth stop for awhile, they noted. That's because the Arizona Department of Water Resources had already issued approvals for 80,000 homes to be served by groundwater that aren't built — more than a decade's worth at current sale levels.

The long-term population explosion of Maricopa County — the U.S.' fastest growing county in raw numbers — will continue, they said.

They emphasized that this is the latest in a long list of farsighted water management actions Arizona has taken over many decades, including construction of the $4 billion Central Arizona Project canal system and approval of the Arizona Groundwater Management Act.

At a June 1 news conference at which a computer model underlying the new restriction was released, Hobbs said, “What the model ultimately shows is that our water future is secure: Water supplies for homeowners and businesses are protected. Growth has been planned for and will continue."

The darker take from Moody's Analytics came out five days later.

The data research firm, which analyzes financial risk, released a report warning that its "climate risk data" concludes that sometime between 2030 and 2040, "100% of Maricopa County's projected population will have high or red flag (highest) exposure to water stress."

In an accompanying map, it showed most of Arizona colored in shades of red, indicating water stressed areas. Maricopa County's projected peak stress level earned it a searing, maroon-colored hue.

'Tangible impacts on real estate markets'

Moody's didn't say the Arizona Department of Water Resources restrictions would stop growth or that water is running out. But it said the type of growth will change, the area's already unaffordable housing will get more so, and developers and cities will have to get more creative to accommodate a shrinking water supply.

"While drought is sometimes thought of as a vague, long-term risk, Arizona's recent announcements demonstrate that the drought will have tangible impacts on real estate markets," the report said.

"Near-term development will continue with a pipeline of approved projects underway, but in the longer term, a growing understanding about the reality of water in Arizona will increase the cost of building and will slow the sprawl which has enveloped the Phoenix area in recent years," wrote Moody's Analytics, which serves clients in commercial real estate nationally. The firm began in 2008 as a subsidiary of Moody's Investors Service and is now independent.   

While businesses aren't affected by the new state limits, they can be even more at risk to "insidious impacts" from drought than homes, because in many cases they use more water, the report said. 

"From data centers that rely on water for cooling to industrial facilities which often use water for their processes, these properties may face substantial increases in operating costs due to water scarcity in the coming decades."

Report is roundly criticized

The Moody's report came under sharp criticism from some leading academic water researchers, not least because its first sentence said inaccurately that Arizona placed limits on housing development in Phoenix. The report's author has since corrected it to say the limits exist "around Phoenix."

The five-page report also didn't define water stress or disclose its data. That's in contrast to the 124-page, Arizona Department of Water Resources report laying out findings of its groundwater model, that projected the Phoenix area's groundwater supply would fall short of what was needed over 100 years. That report relied on 40,000 water level measurements from thousands of wells, hundreds of aquifer tests and streamflow gauge reports.

"The term water stress — what exactly does that mean? We live in the desert Southwest. If they are suggesting that somehow access to water can be complicated and difficult, whatever term you want to use, well sure, the desert Southwest is water stressed," said Cynthia Campbell, Phoenix's water resources management advisor.

"But if you're talking about 100% of Maricopa County's projected population will have to worry about water, I completely reject that. I think that’s a gross overstatement," she said.

Phoenix and many surrounding cities have a wide range of water supplies, including Central Arizona Project and Salt River Project water and treated effluent as well as groundwater, Campbell noted.

But Jay Famiglietti, an Arizona State University water researcher, said he would argue the Phoenix area is already under a high level of water stress.

"It's the desert. It depends on how you define water stress. Is it unfair that precipitation is smaller than evaporation and groundwater extraction, so there’s not much renewable water? That's one definition of stress," said Famiglietti, a global futures professor at ASU's School of Sustainability.

"The context of how much water is available or will be available, whether we call that stress or extreme stress depends on the metrics we use," said Famiglietti. "It's the reality of the desert. It's a high stressed area and it will be more stressed. We just have to come to terms with it."

'We can grow responsibly'

The ADWR groundwater model found that between 2022 and 2121, homes, businesses and farms in the Phoenix area will demand nearly 4.9 million acre-feet more groundwater than can legally be pumped under the state's assured, 100-year water supply rules. That's about 4% of the total, expected groundwater demand.

This supply-demand deficit will mainly be scattered around the fringes of Maricopa County, including fast-growing Buckeye 30 miles west of Phoenix and Queen Creek, 38 miles southeast of it.

Numerous other areas on various edges of the metro area could also experience excessive pumping — enough to drop aquifer levels more than 1,000 feet deep or to lower the water table beneath the level where the aquifer hits impermeable bedrock.

Given the limited areas of the county where pumping will lower the aquifer beneath allowable levels, "the model ultimately shows that our water future is secure and the Assured Water Supply program is working," the governor told reporters.

Growth in most Phoenix-area cities won't be affected at least in the near future because they have their own, separate  designations of assured water supplies that allow new development to continue there, ADWR has said.

"We have shown we can grow responsibly with a common sense approach that puts recycling, conservation and sustainable water use first," Hobbs said. "We will tackle the water challenges we face with integrity and transparency."

'Potentially a canary in the coal mine'

In an interview with the Arizona Daily Star, the author of the new Moody's report declined to comment on statements by the governor or other Arizona leaders.

But the new rules and the model carry "a lot of implications for the commercial real estate industry," said author Natalie Ambrosio Preudhomme, associate director of Moody’s Analytics' commercial real estate leadership team.

"Real estate stakeholders are often asking about the implications of longer term or climate hazards, longer stresses, heat stresses and drought. Those are less clear cut than wildfires and hurricanes, but we get questions about the implications of climate hazards that unfold over a long period," Preudhomme said.

The state announcement of water shortfalls is "potentially a canary in the coal mine" for Phoenix's commercial real estate industry, said Preudhomme.

"Commercial facilities use a lot of water. Manufacturing plants are known to be water intensive. Data centers use water for cooling. Hotels and other recreational facilities rely on a lot of water," she said.

Generally, the viability of the commercial real estate industry is affected by larger real estate market trends, she said — "especially when we look at things like multi-family and hotels, both their market value and property prices.

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"All of those things are likely to be affected by this water situation in the Phoenix area. It will affect the rate and viability of development in the Phoenix area," Preudhomme said.

"As people start to see headlines like this that say Phoenix is running out of water — and I'm not saying that it is — it will be interesting to watch over time, if that affects peoples’ perceptions, then see how it affects real estate markets," she said. 

She said she thinks the Phoenix area's growth will have to start slowing down — "and not just Phoenix," but other areas of the West.

Humans have been able to adapt and prove themselves resilient to wildfires and water shortages, she noted. Plenty of examples exist of companies getting more creative in their water use and individuals improving their water use efficiency, she said.

"But I also think something is going to have to give with the amount of development and the type of facilities that have to be built. There's a limited amount of water there that doesn’t seem like it will be able to keep up with development," said Preudhomme, adding, "I’m not an expert in that."

Assured water supplies

Critics said Moody's report overstated the seriousness of the Phoenix area's water problems. Sarah Porter, director of ASU's Kyl Center for Water Policy, also took the report to task for failing to disclose its underlying data.

She emailed Moody's Analytics seeking information about the data, but got no response, she said. The Star also got no response when it asked Moody's for information on its data.

"The headline for Moody's report is a story about 'water stress strikes developers.' But the way water supply rules work, the development can continue in places that have sufficient water supplies," Porter said. "Those are cities with assured water supply designations from the state. Moody's has framed it that 'this is going to freeze development' in places where it isn't going to."

"The results of the new groundwater model are a moratorium for new certificates of assured supply based on local groundwater. We should be looking to that as  a sign that Arizona’s water supply regulations are working."

Moody's said that in the long-term, existing cities won't get approved for new homes that rely on groundwater, noted  Kathryn Sorensen, a Kyl Center senior researcher. That's inaccurate, because the only impact on cities will occur when they seek renewal of their assured supply status, which happens every 10 to 15 years, Sorensen said. Now they won't be able to get permission to have groundwater comprise more of their assured supply than it already does, she said.

Since at least parts of the Phoenix-area aquifer have been stable or rising in recent years, "in general we have been managing our groundwater fairly sustainably," Sorensen said.

"Given that we have groundwater to fall back on, it's hard for me to imagine it will be that much worse in the 2030s and 40s," said Sorensen. She added that the area has stored millions of acre-feet of CAP supplies underground in the Arizona Water Bank -- a state-financed series of recharge basins where CAP water is placed to let it seep into the ground -- to prepare for future shortages.

Phoenix's Campbell said the groundwater supplies the city has in its assured supply designation are indeed assured -- "If you look at the state model, the 100-year model, there is no stress on the City of Phoenix. The model shows the groundwater declines within the city of Phoenix are okay over 100 years. We don't have declines that show a level of stress that gives anyone a reason to worry the groundwater won't last 100 years. I would say it would likely go further."

But a third Kyl Center researcher, Kathleen Ferris, while agreeing that the new state development limits are a huge step forward, noted that the Colorado River is already stressed, that the CAP won't escape at least some future cuts, and that the state's model shows groundwater supplies are overallocated.

Population in the Phoenix area will rise by 1 million by 2030 and new, high-water-use industries are moving in, she said.

"How could we not be in water stress by 2030?" asked Ferris. "For years, we denied the reality that the Colorado is overallocated and climate change is causing aridification. Business as usual was the order of the day."

Now, with the Colorado River basin states scrambling to find ways to divide a dwindling supply, "Arizona leaders need to accept the results of the Phoenix study and work to ensure that our finite groundwater supplies are managed for the long-term public good," she said.

While Phoenix isn't running out of water, it and all Arizona are clearly losing water each year, to long-term drying, to groundwater depletion and to current and future CAP cutbacks, researcher Famiglietti said.

With Phoenix not on target to reach the state's goal of "safe yield" by 2025, "we must ask if groundwater management acts like those in Arizona and California can be as effective as we need to be for future generations," he said. "Safe yield" occurs when groundwater pumping doesn't exceed the amount of water replenishing the aquifer from rainfall and by artificial means.

Accepting that the Phoenix won't reach "safe yield" is literally called "managed depletion," he said. "It is technically not sustainable."

The challenge for Phoenix area leaders is "to figure out how we can thrive under those conditions. What it does mean us that we can’t have this unchecked growth into the desert, and unregulated use of groundwater. That has to stop. It is stopping," he said.

Continued over-pumping

While the state's new limit on homebuilding will keep the water table from falling farther than the 1,000 feet allowed by state rules, the aquifer's decline will not only not stop, it will accelerate in the future, the state report shows.

The aquifer is expected to fall about 185 feet from the end of 2021 to the end of 2121, it said. It's dropped about 92 feet since before the turn of the 20th century. 

The Phoenix area's annual groundwater overdraft has averaged about 168,000 acre-feet per year since the late 1800s, although it fell to about 30,000 acre-feet annually starting around 2000 due to increased conservation and aquifer recharge by CAP supplies.

But by 2121, the overdraft is projected to balloon to 386,000 acre-feet, the report says. That's because of increased pumping, reduced agricultural recharge of its runoff into the aquifer and reduced recharge of renewable CAP water into farms.

Over time, many scientists have said, continued over-pumping can trigger higher pumping costs, worsening water quality and subsidence, which is  sinking of the ground that can cause fissures that damage roadways and concrete canals.

Ferris, a former ADWR director, pointed to a new agency slide that drives the aquifer's bleak future home visually. The slide shows a near straight line, illustrating its stability from 1980 through 2020. Then, the line drops at a 45-degree angle for the next 100 years.

"Need I say more?" she said.

Expert: Conservation can make up the gap

Porter of ASU's Kyl Center noted the projected total 4.9 million acre-foot groundwater shortfall by 2121 amounts to only a 40,000 acre-feet gap annually. That's less than half of what Tucson residents and businesses use a year.

"Of course" the Phoenix area can save 40,000 acre-feet a year by conserving more, Porter said. "I think cities are planning on conservation as the cheapest water supplies."

But Porter and ADWR officials agree that if CAP supplies are cut due to Colorado River water shortages, Phoenix's long-term outlook would get more challenging. We won't know how much CAP will be cut beyond what's already occurred under past agreements until the seven Colorado River basin states negotiate a long-term agreement to revamp management of the river starting in 2026.

Since the Phoenix area will use about 510,000 acre-feet of CAP in 2023, a 20% cut would take 100,000 acre-feet. That would be more than double the expected annual groundwater shortfall identified in the new ADWR groundwater model, and a 50% cut would chop 250,000 acre-feet a year — more than five times the project groundwater shortfall.

"We have stabilized the system through 2026. We do not know yet what post-2026 will look like," ADWR Director Tom Buschatzke said at the June 1 news conference.

While the groundwater model can be improved after 2026, it's currently "the gold standard for making water supply determinations" for the Phoenix area, Buschatzke said.

He said the assured water supply program provides "a level of certainty for water that's unmatched anywhere in the U.S."