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ESG Industry Report Card: Power Generation

Highlights

The transition away from coal generation--a leader of carbon dioxide (CO2) emissions--is ongoing. But despite being a global focus, the pace of carbon reduction is not uniform throughout the sector and we expect that, by the next decade, coal generation will still represent over 25% of total generation.

Nuclear generation, while a zero-carbon emitter, still has significant environmental risks because of its higher-risk operations and nuclear waste.

Although natural gas generation emits about half the CO2 as coal, we view gas-fired generation as a bridge to a carbon-neutral environment and as an effective interim means to handle the intermittency of renewable generation.

The sector has a considerable influence on local communities, including on customers' electric bills, as a local employer, as a significant contributor to local taxes, and by ensuring safe operations at generating facilities.

The ESG Risk Atlas

May. 13 2019 — To calibrate the relative ranking of sectors, we use our environmental, social, and governance (ESG) Risk Atlas (see "The ESG Risk Atlas: Sector And Regional Rationales And Scores," published May 13, 2019). The Risk Atlas provides a relative ranking of industries in terms of exposure to environmental and social risks (and opportunities). The sector risk atlas charts (shown below) combine each sector's exposure to environmental and social risks, scoring it on a scale of 1 to 6. A score closer to 1 represents a relatively low exposure, while 6 indicates a high sectorwide exposure to environmental and social risk factors (for details see the Appendix). This report card expands further on the Risk Atlas sector analysis by focusing on the credit-specific impacts, which in turn forms the basis for analyzing the exposures and opportunities of individual companies in the sector.

Non-Coal Generation

Environmental exposure (Risk Atlas: 4)

The environmental risks from power generation (excluding coal-fired generation) have a material impact on the sector's credit quality, primarily due to emissions (in the case of gas-fired power) and waste from nuclear power. Social factors are important too, as power generators create local jobs, affect local property taxes, and provide of an essential service that must remain competitive and reliable. We assess the non-coal power sector as being significantly exposed to environmental factors, even though the industry already has taken substantial transformative steps over the past decade to deal with the rising share of renewable generation, which will likely continue. We make the following distinctions across asset classes:

Gas:   We see gas-fired power's environmental exposure stemming mainly from the fact that it creates CO2 emissions. That said, we differentiate gas from coal because gas emits half of the emissions and we believe gas-fired generation is a vital bridge to a carbon-neutral environment, notably to handle the intermittency of renewable generation. This is especially the case in North America given its plentiful shale gas reserves. Depending on the region, gas-fired power generation (like coal) may face headwinds from the rapid rise of renewable capacity and from higher carbon pricing/taxes. Longer-term risks could stem from potential targets for CO2 emissions, as well as battery storage that supports further growth in renewables.

Nuclear:   Major environmental risks for nuclear generation center on the long-term storage of nuclear waste and high water usage. The limited visibility on the technical (and financial) impact of nuclear storage remains an important credit risk, in our view, with high amounts of asset retirement provisions on company balance sheets (unless transferred to the state, in some countries). Finally, given nuclear plants' extreme safety requirements, risks stemming from physical climate change (including rising sea levels) may be low probability, longer-term risk factors. At the same time, we recognize the low-carbon impact of nuclear power. For example, nuclear plants generated nearly 20% of the U.S.'s overall electricity and 63% of its carbon‐free electricity. It thus remains the largest producer of zero-carbon electricity in the U.S., avoiding over 545 million metrics tons (mt) of GHG emissions in 2017, which would have been emitted if all nuclear generation been produced at the national average emissions rate. This compared to hydroelectricity, which avoided 200 million mt, wind (175 million mt), and solar (about 40 million mt).

Renewables/hydro:   Renewable power generation has a stronger environmental assessment than the power industry in general. Key factors we focus on are methane emissions for large hydro (in tropical areas), while land use and its effect on biodiversity also is a growing focus. Generally, hydro, wind, and solar use exponentially more land mass to produce the same amount of electricity as electricity from fossil fuels or nuclear. Such large land use, in certain circumstances, can significantly alter the ecosystem and hurt the environment. This risk has been reduced by the increasing use of land in non-greenfield areas.

Social exposure (Risk Atlas: 4)

We assess social exposure as meaningful. This incorporates the important role that this sector plays within communities as a provider of an essential service that must remain affordable and reliable. Any disruption of these services, as well as any negative impact they may have on nearby communities, could trigger local criticism or political pressures. These sectors are generally invested in having significant community engagement because the company may be a large local employer (that sometimes has unionized staff) and significant contributor to the local property tax base. Renewables/hydro may have somewhat better social acceptance given its environmental benefits. Still, the planning of wind farms is sensitive to local community acceptance while large hydro can face severe opposition if it disrupts the peoples' lifestyles or the landscape.

On the other hand we believe nuclear plants have higher social exposure given the sensitivity around safety. A less likely but high-impact severe nuclear incident could jeopardize a company's license to operate. Although we believe the nuclear industry has made positive strides to improve operations and security, the 2011 Fukushima nuclear incident underscores the severity of financial impacts and abrupt changes to national social and energy policies.

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