The U.S. Environmental Protection Agency has allowed the city avoid the cost of a filtration plant until now.
But if New York State decides to allow natural gas companies to drill for gas in the upstate watershed -- something that environmentalists and city officials fear -- that could pollute the city's water supply and push the EPA to insist on a filtration plant.
The EPA could make that determination, at any time, said the report by the city's Independent Budget Office.
New York City has one of the nation's biggest water systems and more than 90 percent of its drinking water comes from the Catskill/Delaware watershed. The city's decades-long policy of ensuring the water remains pure by buying upstate land has often riled property owners because it stops them from cashing in via development.
Pennsylvania already allows drilling for natural gas in the multistate Marcellus Shale formation, which set off a bidding war for land in the area. New York State recently proposed rules allowing this extraction of energy.
But green groups said New York's draft rules were too lax because, for example, reservoirs would not be shielded with buffer zones. New York City's top environmental official in October called the risk in drilling for natural gas in the upstate watershed especially alarming.
Since the federal government first advised the city that it may require its drinking water to be filtered, something common in many other parts of the country, credit analysts have fretted about the cost of a new plant.
The Independent Budget Office, which mirrors the Congressional Budget Office, assumed that if the state allows natural gas drilling a new plant would be required in 2012. Construction would start three years later and last a decade.
New York City's Water Board sets the rates homeowners pay, but a separate entity, the Municipal Water Finance Authority, pays for improvements to the city's water and sewer systems.
The city collects the revenue for running and maintaining the system and if there is a shortfall, some of the water bond investors can claim all of the funds until they are repaid, Moody's Investors Service said on December 14.
But New York City is not entirely off the hook.
The city has convenanted to operate and maintain the system, regardless of full reimbursement from water and sewer revenues, Moody's said.
One positive, from the credit agency perspective, is the Water Board's willingness to raise rates, Moody's said.
However, elected officials, including Democratic Comptroller William Thompson, in the past few years have fiercely criticized a string of steep rate hikes.
Pressure to mitigate such large rate changes could increase going forward, however, especially amid the ongoing economic downturn, Moody's said.
During the first year of building a water plant, the extra debt needed to pay for it would boost the water bill for a single-family home about $32, the Independent Budget Office said. For a multi-family home, the increase would be $27.
By the time the plant starts up in 2025, single-family homes would see their bills go up $367; a multi-family home would pay an extra $312, the report said.
(Reporting by Joan Gralla; Editing by Leslie Adler)