Every day, the news presents the facts: a lack of rainfall, record heat waves and extreme wildfires. Climate change may have loaded the dice, pushing what could have been a multi-year drought in the western U.S. into a worst-case scenario “megadrought” in which the region may face 10 to 20 more years of these conditions.¹ Even if the drought breaks, the region is expected to become hotter and more arid this century.²

How should these conditions be understood? What happens if they continue?

Among the potential consequences: a threat to California’s and seven other western states’ hydroelectric power supply; a blow to California’s USD30 billion fruit, vegetable and nut crops and Arizona’s agriculture market; western insurance and real estate markets adapting to new climate risks.

And the risks come with opportunities—indeed, pressures—to develop new climate resilience technologies for water supply, water efficiency, water infrastructure, agriculture and buildings.

Here’s how these climate-based phenomena may unfold and how to think about them, including scientific efforts underway and investment considerations, plus preventive steps for property owners and resources for drought prevention and helping its victims.

Snowmelt, dams and development

It doesn’t rain year-round in most of the western U.S. Water falls from the sky mainly from November to March. Up at elevation, precipitation is more intense as mountains wring water from the air. Historically, water froze at the highest elevations, collecting as snow before melting in the spring.

In the mid-20th century, dam and reservoir projects across the West were built to capture this mountain water and provide flood control and water security—access to freshwater during drought years for agriculture and municipal development. Western water rights are allocated by state, tribal, and federal laws and regulations that ranks rights holders’ priority for access.

This western U.S. drought is centuries-level extreme

Now, 64% of western states are experiencing extreme to exceptional drought, up from 5% last summer.³ Major reservoirs are below 50% (Exhibit 1). Recent warmer summers and record-breaking heat waves are evaporating stored water before it can be used. The heat is also drying up soils, leading to less runoff into rivers when rain or snowmelt occurs.

The next few months will likely not bring a reprieve. The National Oceanic and Atmospheric Administration (NOAA) is forecasting that the drought will persist or worsen through October across most of the region.⁴

Exhibit 1: Where is surface water in the western U.S., and where is the demand?

Status of California reservoirs, Mead, and Powell; freshwater use as of 2015 and capacity

Source: U.S. Geological Survey, California Department of Water Resources, U.S. Bureau of Reclamation; demand data as of 2015. California reservoir data is as of August 1, 2021; Lakes Powell and Mead as of July 26, 2021.

The last two decades have been exceptionally dry, despite a few wet years. Scientific work using tree rings revealed that 2000–18 was the driest period since 1575–1603 and the second driest over the complete 1,200-year record.⁵ But 2021 is breaking records, beginning a third decade of drought. Multi-decade “megadroughts” have happened in the past in the western U.S., lasting 30 to 40 years.

The Colorado River basin: Reaching a drought milestone

The Colorado River basin supplies water to 40 million people across several municipalities and rural zones. Its headwaters are in the Rocky Mountains, collecting in a series of reservoirs, including the country’s two largest: Lake Powell and Lake Mead. As of August 2, these two reservoirs were at 32% and 35% of capacity—and falling.⁶

Under the drought contingency⁷ plan the federal and affected states’ governments signed in 2019, if Lake Mead water levels (as projected by the Bureau of Reclamation each August) fall below 1,075 feet the following January, a “Tier 1 shortage” is declared, curtailing water allocations to users in the lower basin (Exhibit 2).

Exhibit 2: A water shortage declaration would cut water to many states; continued drought could affect municipalities

Regions served by the lower basin of the Colorado River

Source: U.S. Bureau of Reclamation.

Such a Tier 1 shortage declaration is expected—for the first time since Hoover Dam was opened in 1936—in mid-August 2021⁸ (Exhibit 3). If the shortage is declared, states will experience reductions in their share of the Colorado River, based on preexisting seniority or rights to water. Cuts would be 18% in Arizona, 4% in Nevada and 3% in Mexico; California would not be cut.⁹

Exhibit 3: Lake Mead, far below historic levels, may have its first water shortage declaration since the Hoover Dam’s construction

Lake Mead lake surface elevation

Source: Bureau of Reclamation July 2021 24-Month Study and historical levels; data as of July 15, 2021. BoR: Bureau of Reclamation. Recent lake observations are end-of-month averages.

Almost all of the Arizona reduction will affect the Central Arizona Project (CAP).¹⁰ A Tier 1 shortage in Arizona would reduce the water supply to agriculture in the Central Arizona Project by 65%, leaving untouched municipal Tucson and Phoenix, as well as industrial and tribal allocations. Tiers 2 and 3, which the July Bureau of Reclamation report forecast would either be met or be close to being met in the future, would affect users beyond agriculture.¹¹

To regain water, average snowfall—which climate change is making less likely—won’t be enough. Snowfall in the mountains at historical averages is insufficient to replenish soils and reservoirs, because hotter temperatures are reducing runoff and river flows from rain and snowmelt.

Despite an 80% of average snow season in the mountains above the Colorado River’s headwaters in 2020–2021, corresponding river flows were only 30% of average. The region needs more snow—a wetter-than-average winter or multiple wet winters—to achieve past runoff levels.

Hydropower is at risk

The drought’s continuation increasingly threatens the hydroelectric power supply for California and along the Colorado River (Exhibit 4). Fewer turbines can operate if water levels fall below intake pipes, and reduced pressure from the weight of the water behind dams lowers electricity production.

This effect is already being seen in California this year, with 2021 hydroelectric power production projected to be 19% lower than in 2020. In 2019, a more average hydropower year, hydro-produced electricity represented 19% of the total in-state generation. In response to expected hydropower reductions, the state made an emergency proclamation in July 2021 to suspend requirements in order to obtain additional power capacity to avoid blackouts. On August 5, 2021, the power plant at the state’s second-largest reservoir, Lake Oroville, shut down due to low reservoir water levels for the first time since it opened in 1967.^{12, 13}

Exhibit 4: Historic drought increasingly threatens California’s hydroelectric power supply

Annual California hydroelectricity production

Source: California Energy Commission; data as of July 20, 2021.

Similarly, power generation at Lake Powell may be threatened in the next two years if water levels drop further.¹⁴ Power could be cut to Arizona, Colorado, Nebraska, Nevada, New Mexico, Utah and Wyoming.

The impact of drought on farmland and urban centers

What impact would water scarcity have on agriculture and urban centers? Most freshwater in the western U.S. is allocated for agricultural irrigation (Exhibit 5).¹⁵ When droughts develop, farms are the first to receive reductions of surface water.

Exhibit 5: Most freshwater in the West goes to agriculture

Total freshwater withdrawals by category (acre-feet/yr)

Source: U.S. Geological Survey; data as of 2015.¹⁶

In California and Arizona, where groundwater resources have been historically tapped in periods of drought, regulations guide how much groundwater can be pumped to meet surface water shortages. (Groundwater is a resource that renews very slowly, over years and centuries, and has already been subject to long-term depletion.) During water shortages, farmers must decide whether to purchase more costly water for delivery, pump groundwater (if allowed, also costly) or leave their land fallow: cut down existing trees and plants or not plant.

What could that mean? Historically, California has grown a significant portion of U.S. produce by value, for example in 2019:

• 74% of fruit and nuts (USD21.4 billion)
• 44% of vegetables and melons (USD8.3 billion)¹⁷

In March 2021, the California State Water Project—serving 27 million people and 750,000 acres of farmland –reduced allocations by 95%, to just 5% of total requests. Such low allocations were last seen in 2014, mostly affecting agriculture—and resulted in California crop revenue losses of about USD1.7 billion (2014–15), concentrated in locations without access to groundwater.¹⁸

California Governor Gavin Newsom made a voluntary request in July that residents reduce their water use by 15% to avoid mandatory cuts.¹⁹ On August 3, the State Water Resources Control Board voted to issue an Emergency Curtailment Order for the Sacramento-San Joaquin Delta Watershed, banning farmers from pulling water from major rivers and streams. The new order is expected to go into effect by mid August and is necessary to maintain freshwater flows through the Delta to avoid saltwater from the Pacific contaminating the water supply.

Arizona farmland

A Tier 1 shortage declaration on the Colorado River would reduce allocations by 65% for Central Arizona Project farmland, lowering crop yields where groundwater is insufficient to replenish supply.

There is no precedent for a Tier 1 shortage.

While the leafy green farms in Yuma, Arizona (comprising 90% of the U.S. winter greens market) have priority rights in a Tier 1 shortage and will avoid cuts, agriculture in Pinal County (cotton, feed crops, corn, vegetables, cattle and milk) is expected to take the majority of a Tier 1 cut. In 2019, by value, Arizona as a whole produced 11% of U.S. vegetables and melons—a market totaling USD2.1 billion.²⁰

Agricultural inflation pressure

The continuing drought will alter agricultural patterns in response to reductions in water allocation. Less water can drive up agricultural prices in two ways: in response to scarcity, as food production declines and because of the rising costs of meeting the need for water as it becomes more expensive. Additionally, the loss of agricultural productivity in California and Arizona will be felt in local economies and the transportation of goods. Rising inflation is already being seen in agriculture metrics (Exhibit 6).

Exhibit 6: Drought is causing prices to rise in U.S. agriculture

Inflation in fruits and vegetables, meat and dairy (3mo change, 2006–2021)

Source: Bureau of Labor Statistics; J.P. Morgan Asset Management; data as of June 30, 2021.

How 2020 and the 2021 wildfire season may shape insurance

Drought dries out vegetation and creates ideal conditions for wildfire to spread. During 2020, California experienced five of its worst six wildfires on record by acres burned (Exhibit 7). California’s 2021 Fire Season Outlook estimates an increase to above-normal fire danger. The National Interagency Fire Center in July predicted above-normal fire potential for every western state except Arizona and New Mexico in August and September.²¹

Exhibit 7: After a record 2020 wildfire season, the 2021 outlook is above normal

20 largest California forest fires by thousands of acres burned, 1983–2020

Source: California Department of Forestry and Fire Protection; data as of April 8, 2021.

As of August 9, the Dixie Fire was underway and already the second largest in California history. The 2021 California wildfire season has only just begun and typically peaks in the fall.

The extreme wildfire season of 2020 and 2021 highlights the risk of wildfire in California and the exposure of the regional insurance and real estate markets. According to the U.S. Forest Service, 11.2 million people in California living in 4.5 million homes—33% of all California homes—are in the wildland urban interface, the transition zone between wilderness and the built environment.²²

Insurance companies, increasingly aware of this danger, are likely to want to cancel insurance for homes in harm’s way. To prevent them from doing so, California regulations allow the state’s insurance commissioner to declare a moratorium on such cancelations or failures to renew policies. Last year, such a moratorium was declared for the second time; on November 5, it was used to protect for one year an estimated 2.1 million property holders (18% of the residential insurance market) living within or adjacent to areas affected by 2020 wildfires.²³

Loss of home insurance can lower real estate prices in the affected regions. Properties outside those covered by the moratorium have begun to see a loss of insurance coverage.

To address gaps in the insurance market due to wildfire and other climate risks, the California Climate Insurance Working Group released new recommendations for changing how insurance premiums are calculated. They would expand private market coverage in California and tie premiums to climate change-based catastrophe risk, including wildfire, heat and floods.²⁴

The working group also suggested climate resilience plans to avoid future damages. Such plans include retrofitting buildings to the 2018 International Wildland Urban Interface Code—a code similar to that required of new buildings in California fire zones. The code provides a return of USD2 for every USD1 invested, but could yield as much as a USD8 benefit.

Without changes to the insurance market, or projects to improve resiliency for buildings and communities, private insurers may exit the region due to wildfire, likely impacting property values in the affected areas.

What does this all mean?

Major reductions in carbon emissions are required to slow and eventually halt continued climate change. In the near term, climate change will continue unabated. Without significant snow and rain to replenish reservoirs, coupled with cooler temperatures, surface water availability will continue to decline. Water managers in the West have been planning for drought by pushing for efficiency and new water management practices to increase water security.

Investing in a time of climate change

Though U.S. produce, western hydroelectric power and the real estate and insurance markets face serious risks, the outlook is not entirely dire. The deployment of new technologies will be necessary to adapt to the challenges of drought. Current climate conditions have created an increased focus on developing technologies and projects to improve water, food and energy security.

These include:

• Innovative developments around water, including new infrastructure projects and water recycling, efficiency, treatment and purification technologies.
• Innovation in agricultural technologies, especially the efficient use of water, increasing production and ways to grow more with less water—or in new locations.
• Reduced hydropower, once a steady supply of renewable energy in the West, due to insufficient reservoir levels will provide a window for deploying other clean energy or energy efficiency technologies to meet clean energy/ fossil fuel reduction standards.

Taking personal action

If you own property where wildfire risk is a concern, you can take steps to reduce the likelihood of fire damaging your property. Measures recommended by the U.S. government and the 2018 International Wildland Urban Interface Code^{27, 28}include:

• Replacing wood or combustible shingled roofs with noncombustible materials
• Creating a series of safety zones around structures by reducing and trimming vegetation
• Reducing all flammable materials close to structures and removing all debris
• Covering external vents with mesh to prevent embers from entering the home

For further resources on wildfire prevention and victims’ recovery, we recommend these two philanthropies: the American Red Cross and Team Rubicon. To support research, conservation and land use planning, consider the Nature Conservancy and the Union of Concerned Scientists.

Amid this evolving, unprecedented set of climate-based risks, we will be closely monitoring the outlook, as well as the solutions arising to meet these challenges. Bringing together an understanding of climate science and financial markets, we will continue to offer assessments of how these evolving conditions may affect investors, industry sectors and citizens.

¹ A. Park Williams, Edward R. Cook, Jason E. Smerdon, et al., “Large contribution from anthropogenic warming to an emerging North American megadrought,” Science 368, no. 6488, April 17, 2020, 314–318. 

² Ben Cook, Justin S. Mankin, Kate Marvel, et al., “Twenty-first century drought projections in the CMIP6 forcing scenarios,” Earth's Future 8, no. 6, June 2020: e2019EF001461. 

³ U.S. Drought Monitor, August 5, 2021. 

⁴ U.S. Seasonal Drought Outlook, Climate Prediction Center, NOAA, July 15,2021 and valid July 15 to October 31, 2021. 

⁵ Drought conditions as of as of July 20, 2021. Measuring the space between rings in living and preserved trees allows for estimating soil moisture over time. See note 1. 

⁶ “Lower Colorado water supply report,” U.S. Bureau of Reclamation, August 2, 2021. 

⁷ The plan was developed and signed by the Department of the Interior, the U.S. Bureau of Reclamation and representatives from the seven Colorado River basin states. The plan manages risks from ongoing drought to protect the water supply through voluntary reductions and management plans for further reduction in the supply. 

⁸ “24-month study, interior region 7, Upper Colorado Basin,” U.S. Bureau of Reclamation, July 20, 2021. 

⁹ Current guidelines for Colorado River allocations via the 1922 Colorado River Compact will be renegotiated before they are set to expire in 2026. Tier shortage allocations are made by the 2019 Drought Contingency Plan. 

¹⁰ A 336-mile system of canals, generating and pumping stations supplying Colorado River water to Arizona agriculture and 80% of the state’s population. 

¹¹ “Colorado River shortage factsheet,” Central Arizona Project, Arizona Department of Water Resources; accessed July 27, 2021. 

¹² “Short-term energy outlook, independent statistics and analysis,” U.S. Energy Information Association, July 7, 2021. 

¹³ “California Hydroelectric Statistics and Data,” California Energy Commission. 

¹⁴ The threshold would be water levels dropping below 3,490, to an elevation of 3,525 feet or lower. 

¹⁵ Freshwater refers to all nonsaline water sources. It includes both water at the surface—what you see in rivers and reservoirs—and groundwater, which is pumped from below the surface, sometimes at great depths. 

¹⁶ Cheryl A. Dieter, et al., “Estimated use of water in the United States in 2015,” U.S. Geological Survey Circular 1441, 2018. 

¹⁷ “Cash receipts by selected commodity,” Economic Research Service, U.S. Department of Agriculture, February 5, 2021.

¹⁸ Jay Lund, Josue Medellin-Azuara, John Durand and Kathleen Stone, “Lessons from California’s 2012–2016 drought,” Journal of Water Resources Planning and Management 144, no. 10, October 2018.

¹⁹ Executive Order N-10-21, Executive Department, State of California, July 8, 2021. 

²⁰ See note 15. 

²¹ National Interagency Fire Center. The NIFC comprises the national fire management programs of many federal agencies, plus partners including the National Association of State Foresters, the U.S. Fire Administration, the National Weather Service and the U.S. Department of Defense, and covers one-fifth of the total land area in the U.S. 

²² Sebastian Martinuzzi, et al., “The 2010 wildland-urban interface of the conterminous United States, Research map NRS-8,” U.S. Forest Service, U.S. Department of Agriculture, 2015. 

²³ “Insurance commissioner Lara protects more than 2 million policyholders affected by wildfires from policy non-renewal for one year,” California Department of Insurance press release, November 5, 2020. 

²⁴ “Protecting communities, preserving nature and building resiliency,” California Department of Insurance, Climate Insurance Working Group, July 22, 2021. The recommendations were released July 22, 2021. 

²⁵ Those standards are currently a transition to 50% non-fossil fuel sources by 2025 and to 60% by 2030.

²⁶ The Flaming Gorge Reservoir (in Utah and Wyoming), the Blue Mesa Reservoir (in Colorado) and the Navajo Reservoir (in southern Colorado and northern New Mexico). 

²⁷ https://www.ready.gov/wildfires. 

²⁸ The code can be accessed online via the International Code Council: https://codes.iccsafe.org/content/IWUIC2018/effective-use-of-the-international-wildland-urban-interface-code.

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