Seven western states and the U.S. Bureau of Reclamation (USBR) have one year to renegotiate the operating framework for the Colorado River before operating guidelines expire in 2026. If the states fail to reach a consensus by the summer, federal intervention and litigation are more likely.

At stake are water allocations, curtailments, storage, and other general operating conditions--all of which S&P Global Ratings believes could affect the credit quality of water issuers in the seven-state area. Downstream challenges facing these issuers from the renegotiation include increased capital and operating costs if more expensive alternatives are required or new contingency plans if operating guidelines revert to pre-2007 levels, all of which could influence rate affordability.

Chart 1

Overview

The Colorado River basin provides water to 40 million people across seven states and Mexico. The current guidelines have been insufficient to protect river quality given initial over-allocation, population growth, hydrological volatility, and evaporation, which stresses supply predictability for river users and could threaten growth and development in some areas.

We consider timeliness in executing the negotiations an important consideration to avoid additional operating stress and protect water predictability. If a consensus solution is not achieved and guidelines revert to pre-2007 norms, the federal government would set allotments annually, which we believe would compromise the planning and predictability of water supply for offtakers and would be viewed negatively for rated issuers throughout the region. While USBR can address extraordinary circumstances to meet human health and safety needs and has done so with Central Valley Project (CVP) water in the past, its ability to override legally established water rights is uncertain and increases litigation risk.

The draft Environmental Impact Study (EIS) deadline is the summer of this year. Developing a consensus solution for inclusion in the draft EIS best positions the stakeholders and federal government to analyze and execute new operating guidelines. However, failure to achieve a seven-state solution for inclusion in the draft EIS does not preclude one from being included in the final EIS. We'll monitor the negotiations as well as the federal government's role in them.

Competing Interests Vie For A Dwindling Supply

Agricultural versus municipal uses

The river provides water for 40 million people, 5.5 million acres of agriculture, and habitat protection across the southwestern U.S. and Mexico. While agriculture is the largest use of water, as charts 2 and 3 demonstrate, some states (such as Nevada) and offtakers use their allocations primarily for municipal and industrial use. Agriculture is not only the dominant user, but also, in many cases, the senior-most user. While relatively small shifts in use from agricultural to municipal can provide substantial conservation gains, the transition can be politically challenging, may negatively influence the cost and availability of food, and could have environmental repercussions.

Chart 2

Any construct that includes fallowing agricultural land or transfers water from a farmer with senior water rights to a junior offtaker will likely require compensation. For example, a critical aspect of the 3 million acre-foot reduction through 2026 that the states agreed to in 2023-2024 included financial incentives to farmers for a three-year period. Some of those payments are expected to be funded through the Inflation Reduction Act, though any payments yet to be contracted may be frozen.

It's currently unclear if alternative funding will be available if additional federal funding is unavailable. Colorado and Utah have already begun pilot programs to pay farmers to fallow. Regardless of whether payments come from the federal government or from other sources, we expect the balance and optimization of agricultural and municipal uses to be a critical tool in ensuring a sustainable water supply after the current guidelines expire.

Chart 3

Upper Basin Versus Lower Basin Alternative Proposals

Under the Colorado River Compact of 1922, the Upper Basin and Lower Basin are each allocated 7.5 million acre-feet annually in Colorado River supply. The Lower Basin states of Arizona, California, and Nevada generally use most of their annual allocation, which is dependent on releases from Lake Powell and Lake Mead to meet the needs of their significant population centers and agricultural users. Meanwhile, the Upper Basin states of Colorado, New Mexico, Utah, and Wyoming generally use about 4.5 million acre-feet of their allocation, which is mostly dependent on snowpack for crop irrigation and hydropower generation. Negotiations have been contentious, including disagreements over even some of the basic principles of compact compliance.

The Lower Basin plan proposes to measure total system contents, including reservoirs across the Upper and Lower basins to determine required curtailments. When water levels are below 69%, Lower Basin users would absorb most of the reductions. When water levels drop below 38% reductions would be shared by all seven states and Mexico. Since 1970, water levels were below 38% in only one year. Hydrology in the basin has been volatile for a century, as chart 4 demonstrates. Several factors affect river levels, including precipitation, snowpack, and evaporation. An operating framework that improves the predictability and reliability of Colorado River allocations and storage would be credit supportive--even if that means reduced allocations under certain scenarios.

Chart 4

By contrast, the Upper Basin proposal includes only mandatory cuts for the three Lower Basin states if Lake Mead falls to a certain threshold, while offering the four Upper Basin states the option to undertake voluntary reductions. The Upper Basin's proposal doesn't provide specific commitments for its voluntary reductions due in part to the relatively less-predictable nature of snowpack--its main water source. It also considers permanent reductions in the Lower Basin that factor in evaporative and transit losses. In addition, the Upper Basin's approximately 4.5 million acre-foot annual usage hasn't come close to its 7.5 million acre-foot allocation, as demonstrated in chart 5--and given the health of the river it's unlikely that will ever occur. One of the Upper Basin's priorities for the post-2026 operations is to be more responsive to actual hydrology at Lake Powell and Lake Mead. As such, the Upper Basin states are asking for a monthly meeting with the USBR to monitor drought conditions to help avoid a repeat of 2021, when emergency reservoir releases were unanticipated.

Chart 5

Available supply levels can influence a region's population growth and economic development if not managed carefully. S&P Global Ratings generally views population growth as having an offsetting effect on credit quality. While a larger customer base means higher revenue, it also requires an often-significant investment in assets to ensure supply sufficiency. We believe utilities that are reliant on aggressive growth assumptions without identified (and credible) water supplies are exposed to potential credit risks from the financial burden of securing additional supply and the potential for stranded assets, depending on infrastructure planning.

Other players: Tribes and Mexico

In addition to the seven states, there are 30 tribes with water rights to basin supply; however, many don't have the infrastructure to access it. Tribes hold senior rights to approximately 20% of the total river--in Arizona, it's closer to 40%. As with agricultural users, we expect some degree of financial compensation is possible, but we believe payment for unused tribal entitlements is unlikely since it doesn't produce any additional available capacity. The potential influence of tribal outcomes on the state where tribes are located is uncertain but could influence allocations.

Under the 1944 treaty, Mexico has rights to 1.5 million acre-feet (scaled back for drought). Given the river's persistent structural imbalance, both the U.S. and Mexico have taken cutbacks almost annually. Mexico, which relies heavily on two stressed water supplies--the Colorado and the Rio Grande rivers, also faces climate challenges, groundwater overdraft, and contamination, all of which are creating significant water supply stress. While changes to Mexico's allocations aren't part of current renegotiations, potential additional reductions in its water deliveries are included in the modeling and alternatives presented by the USBR's alternatives report.

The Federal Government's Role

The future operating framework and supply landscape will remain influenced by state and federal factors. The alternatives development phase of the post-2026 process began in 2023, when the USBR released a SEIS, (as highlighted in our article, "USBR Proposal Raises Water Supply Uncertainty For Lower Basin States; Impact May Trickle Down To Future Negotiations," published April 27, 2023, on RatingsDirect). The SEIS provided two alternatives in addition to a third "no action" alternative. As S&P Global Ratings anticipated at the time of that article's publication, none of the alternatives were executed.

Alternatives proposed by previous administration

During the last week of the Biden administration in January 2025, the USBR released the alternatives report. Due to the timing of the release, the change in administration, and the nature of the alternatives presented, S&P Global Ratings believes it's unlikely that the stakeholders will adopt any of the USBR alternatives within the draft EIS, but it may encourage greater collaboration in the interim or serve as a starting point for evaluation.

New administration will likely be more active in negotiations

We believe the Trump administration will opt to develop, or at a minimum, amend the alternatives to reflect the perspectives of the incoming appointees of the Department of the Interior and USBR as well as the new assistant water and science secretary, who has not been confirmed. We also believe the administration's Jan. 24, 2025, executive order (No.14181) suggests that it may take a more active role in the negotiation and evaluation process than the prior administration.

However, we still believe that a seven-state consensus solution, if developed, would be supported by the federal government, based on past practice.

Recent federal funding for water infrastructure and drought mitigation

In addition to providing leadership during the negotiating process and advancing the EIS and National Environmental Policy Act (NEPA) process, the federal government recently provided funding for water infrastructure and drought mitigation.

For example:

• The Bipartisan Infrastructure Law: Provides $8.3 billion for water infrastructure projects to support drought resilience.
• The Inflation Reduction Act: Provides $4.6 billion for drought mitigation.

We'll monitor the availability of federal funding for such projects and, if unavailable, assess the cost and availability of other funding alternatives.

The Clock Is Ticking

Should the states fail to reach a consensus by the summer deadline, we believe it would increase operating uncertainty for all rated water issuers in the Upper and Lower basins. A return to the pre-2007 operating guidance would decrease supply predictability and require greater contingency planning. We believe supply and demand management is critical to addressing the future, including alternative water supply development. While drought-resilient supplies will bolster reliability, the development costs may pressure water rate affordability for some--especially in areas where already high rates leave less room for adjustments.

We'll assess the negotiation's success or failure as well as its influence on ratings after the summer deadline passes.

Related Research

• U.S. Not-For-Profit Utilities 2025 Outlook: Rough Water Likely Will Underscore Credit Trends, Jan. 15, 2025
• California Utilities Enter Period Of Significant Capital Spending That May Strain Water And Sewer Rate Affordability, Oct. 3, 2024
• U.S. Water Utilities 2024 Outlook: Managers Navigate Rising Risks From A Position Of Strength, Jan. 18, 2024
• Arizona Water Utility And Local Governments Credit Brief: Future Rating Stability Boils Down To Managing Supply Variability, Nov. 9, 2023
• USBR Proposal Raises Water Supply Uncertainty For Lower Basin States; Impact May Trickle Down To Future Negotiations, April 27, 2023
• Western U.S. Drought: Declining Supply, Rising Challenges, Aug. 16, 2022
• How The Western States Plan Is Critical To Ratings As Colorado River Flows Slow To A Trickle, Oct. 18, 2021

Editor: Michelle Jew