Although most North American utilities are well-positioned to weather a global recession in 2020, S&P Global Ratings said in a March 19 report utilities most exposed to downside risk are those with a high proportion of commercial and industrial customers, cyclical nonutility businesses and large construction projects.
S&P Global Ratings' base case scenario includes a global recession this year brought on by measures to contain the novel coronavirus, with S&P economists forecasting a second-quarter contraction of 6% before recovery begins in the second half of 2020. But utilities are likely to be spared from the worst of any economic effects.
The utility sector will likely experience reduced sales volumes in the near term as large events like sporting events and concerts are postponed, and federal and local governments implement social distancing procedures, credit analyst Obioma Ugboaja wrote. But utilities "provide an essential service to consumers and businesses" that will likely protect their bottom line.
While some utilities benefit from decoupling, a regulatory mechanism that protects the companies' margins regardless of sales volume declines, it is not available in every state. As a result, utilities most at risk are those without decoupling, where a large proportion of their customer base is commercial and industrial, and that already have negative outlooks or limited cushion in their financial risk profiles, Ugboaja said.
"Electric utilities with disproportionately large commercial and industrial customers could be vulnerable, should the COVID-19 outbreak persist beyond our base-case expectations," the credit analyst wrote. Utilities with such exposure include ALLETE Inc., Entergy Corp. subsidiary Entergy Louisiana LLC and MidAmerican Energy Co., a Berkshire Hathaway Energy company.
"This reflects our view that electric utilities whose revenues largely depend on commercial and industrial activity could see weaker cash flows if the outbreak persists, heightening regulatory lag, and weakening their ability to earn their authorized returns," Ugboaja added.
Utilities may also see additional credit risks if they have cyclical nonutility businesses partially tied to other macroeconomic factors. This includes utilities with exposure to midstream, such as Dominion Energy Inc. and CenterPoint Energy Inc., and construction services, such as MDU Resources Group Inc.
A third risk factor is that, "a persistent viral outbreak heightens project execution risk for certain large scale projects," especially for capital-intensive projects already facing delays and regulatory setbacks, according to the credit agency. One example is Southern Co.'s expansion project at the Alvin W. Vogtle Nuclear Plant, where majority project owner and Southern unit Georgia Power Co. and its partners are on a tight schedule to finish building two nuclear reactors.
Other utilities include Dominion and Duke Energy Corp., with risk stemming from their ownership of the Atlantic Coast Pipeline, LLC project.
S&P Global Ratings estimates regulated utilities will issue about $7 billion in equity in 2020, compared to more than $30 billion in equity issuance in 2019.
"We now believe that market volatility may put a damper on previously planned equity issuance, exposing those with reduced cushion in their financial measures," Ugboaja said. "Moreover, we recently observed a general tightening of the commercial paper market but utilities now appear to be effectively managing to extend maturities."
S&P Global Ratings assessments are in line with other credit agencies and equity analyst commentary on how the utility sector will fare. Moody's noted March 18 that utilities face risks from market volatility and reduced demand from C&I customers. CreditSights analyst Andrew DeVries wrote in a March 19 note that most utilities will not immediately need additional equity during the current selloff, though the sector has been impacted by U.S. equity markets' recent turbulence.
"[W]e do not expect to see a widespread weakening of credit quality for the sector because of COVID-19. That being said, the virus' outbreak presents some uncertainty, and we could see selected rating actions as we continue to monitor developments," Ugboaja wrote.