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Credit rating agencies see utilities well-positioned for 2018

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Essential Energy Insights - February 2021

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Six trends shaping the industries and sectors we cover in 2021

Six trends shaping the industries and sectors we cover in 2021


Credit rating agencies see utilities well-positioned for 2018

Strong regulatory support provides the backbone for a stable outlook for regulated U.S. electric and gas utilities in 2018, according to credit rating agencies.

"Low commodity prices and a focus on cost cutting is providing headroom to utilities to increase rates for the recovery of infrastructure-related investments without causing undue pressure on customer bills," Fitch Ratings analyst Shalini Mahajan wrote in a Nov. 22 report. "Tax reform remains a wild card. However, we believe the sector may remain largely unscathed."

Fitch said it does not expect much ratings movement in the regulated utility sector in 2018 with SCANA Corp. subsidiary South Carolina Electric & Gas Co. and Southern Co. subsidiary Georgia Power Co. seen as potential exceptions based on new nuclear risks.

Parent holdings companies, such as Duke Energy Corp. and DTE Energy Co., which have taken on debt to finance recent acquisitions remain at risk of a downgrade, according to Fitch. Duke Energy's $6.7 billion acquisition of Piedmont Natural Gas Co. Inc. also involved the assumption of about $2 billion in debt.

"Fitch expects utility holding companies to continue to shed unregulated businesses and focus on delevering after unrestrained debt funded M&A," Mahajan wrote.

Despite some instances of regulatory pushback, especially for large troubled capital projects in South Carolina and Mississippi, Moody's also has a stable outlook on the regulated utility sector.

"We expect U.S. utilities to continue to benefit from credit supportive relationships with state regulators, underpinning their ability to earn a fair return on their invested capital and generate stable operating cash flows through timely cost recovery," Moody's analysts wrote in a Nov. 2 report.

The financial condition for utilities is expected to stay healthy with credit metrics sustained at "sound levels" despite flat and declining load growth, according to Moody's.

"What's allowed them to continue to sustain sound financial metrics is really ... they've been able to invest and they've invested a lot in asset base, about 7% annually for the past 10 years," Moody's analyst Lesley Ritter said in an interview. "And that in combination with cost cutting, bonus depreciation has allowed them to kind of sustain strong metrics despite the fact that they face declining ROEs and declining to flat load growth."

Ritter added that the rate impact has been "flat to customers" as utilities realize the benefit of lower fuel costs, especially the huge decline in natural gas prices, to create headroom in the monthly utility bill.

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Opportunity or disruptor?

Moody's noted utilities have used headroom in the utility bill to invest in renewables, which have no fuel costs and low O&M costs.

American Electric Power Co. Inc., for example, announced plans in late July to purchase the $4.5 billion, 2,000-MW Wind Catcher Wind Farm being built in the panhandle of Oklahoma. Acknowledging the company's relatively flat load growth, AEP's top executive said the shift away from baseload generation investments "emanates from the management of risk."

"This business is about optimization and efficiency and building the next central station generation facility is the most risky investment that we can make," AEP Chairman, President and CEO Nicholas Akins told S&P Global Market Intelligence.

Ritter noted that favorable economics help drive this investment: "Renewables are actually competitive now."

Moody's, in its report, points out that the all-in cost for wind generation in the Midwest is about $25 per MWh, compared to the operating cost for a coal plant at about $39 per MWh.

"It's lower cost. It's green. And it's economic," Ritter said.

Fitch Ratings said renewable energy, especially distributed generation, could be a potential disruptor for the electric utility sector.

"Attractive tax subsidies, falling costs for solar panels and customer preferences are driving increased penetration of distributed generation," Mahajan wrote. "While not a key rating driver in the near term, given a low base, this is a worrisome long-term trend for utilities, and requires constructive rate design solutions to minimize revenue loss and cross-subsidization. Development of an affordable storage solution could spark customer defections from the grid and further upend the traditional utility model."

Fitch said it is "encouraged" to see state regulation in California, Hawaii and Arizona evolving to address the penetration of distributed energy resources and increased adoption of battery storage and electric vehicles.

The Moody's analyst said investments such as AEP's Wind Catcher project help shield utilities from distributed generation. As long as utilities offer cheaper service than the cost of distributed generation, customers should favor the cheaper provider, Ritter said.

S&P Global Ratings contends utilities are doing a much better job of being quick adapters when it comes to clean energy, technology and other potential disruptors.

"We believe that — and this is informed by countless interactions during the year with utility management teams — that utilities are not sitting by and watching the world change around them," S&P Global Ratings analyst Kyle Loughlin said in a recent interview. He added that prudent management teams are "making tactical changes to adapt so that they can ensure that their businesses are successful in the future."

S&P Global Ratings and S&P Global Market Intelligence are owned by S&P Global Inc.