Coal combustion residuals (CCRs), also known as coal ash, are byproducts of sediments or particulate matter that stem from burning coal in coal-fired power plants. Coal ash has been around for a very long time, but never garnered much attention until the 2008 Kingston, Tenn., spill and the 2014 Dan River spill. In those cases both the Tennessee Valley Authority (TVA) and Duke Energy were largely viewed as responsible, since they owned the assets in question. In the wake of both incidents, the Environmental Protection Agency (EPA) developed federal regulations governing how coal ash is to be managed, stored, and disposed, but the enforcement of such regulations was mainly left to the states, creating a lack of consistency in how these rules would be enforced. Coal ash is generally disposed of either in landfills or in surface impoundments, also known as ash ponds.
U.S. vertically integrated utilities have historically managed to address coal ash risks through effective cost recovery methods for capital spent to address environmental mandates (see table 1). This is consistent with our view that most regulatory jurisdictions are generally supportive of credit quality. (Please see "U.S. And Canadian Regulatory Jurisdiction Updates And Insights: November 2019," Nov. 4, 2019.)
|Regulatory Mechanism Used By Electric Utilities To Recover Environmental Compliance Costs-- Select States|
|State||Cost recovery method (a)||State regulatory assessment (b)|
|NC||General Rate Case||Strong|
|IN*||General Rate Case||Strong/Adequate|
|MI||General Rate Case||Strong|
|MO**||General Rate Case||Strong/Adequate|
|KY*||General Rate Case||Strong|
|WI||General Rate Case||Strong|
|SC||General Rate Case||Strong/Adequate|
|IA||General Rate Case||Strong|
|WV*||General Rate Case||Strong/Adequate|
|GA*||General Rate Case||Strong/Adequate|
|WY||General Rate Case||Strong/Adequate|
|TX||General Rate Case||Strong /Adquate|
|OK*||General Rate Case||Strong/Adequate|
|MN*||General Rate Case||Strong/Adequate|
|AR*||General Rate Case||Strong/Adequate|
|NM||General Rate Case||Adequate|
|*Separate environmental rider for emission control investments. §Proposed **Limited rider, subject to prudence review every 4 years. Sources: (a) S&P Market Intelligence Sources: (b) S&P Global Ratings|
We think the enviromental risks remain high for regulated electic utilities that own unlined coal ash ponds because of their proximity to nearby bodies of water (see chart 1). Lining essentially refers to the process of installing durable materials inside the coal ash pond to prevent potenial slippage of coal ash particulate matter into nearby rivers, streams, or other bodies of water. And while regulations governing unlined coal ash ponds have historically been lax, this can change. For example, prior EPA rules essentially allowed unlined coal ash ponds still operating to continue receiving coal ash. But, the 2018 U.S. Court of Appeals decision effectively ordered the EPA to tighten its coal ash rules for unlined coal ash ponds.
The court decision on the EPA could focus the attention of states looking to craft their own coal ash rules. As such, a trend toward more restrictive coal ash environmental regulations in coal-heavy states may dampen prospects for the electric utilities operating in them, particularly those who do not have strong cost recovery countermeasures.
North Carolina Has Sharpened Its Focus On Coal Ash
In April 2019, the North Carolina Department of Environmental Quality (NCDEQ) ordered Duke Energy to fully excavate its remaining coal ash basins in the state. A subsequent ruling over the summer effectively affirmed the NCDEQ's legal authority to determine the method of coal ash site closure. Duke estimates that the cost to comply with the NCDEQ's order could be as high $5 billion over the next several years. In our opinion, this development in North Carolina is indicative of how environmental standards can tighten, irrespective of the cost burden for utilities. Duke Energy is currently appealing this NCDEQ order.
Will Other States Follow North Carolina?
North Carolina's recent environmental push in dealing with coal ash remediation could prompt other states to adhere to a similar path. But how the other states will approach this is hard to say, and the effects of any such moves may be marginal for electric utilities. For example, Illinois and Virginia recently passed more restrictive laws aimed at removing coal ash that we do not expect will materially affect the credit quality of electric utilities operating in these states. Specifically, while the Illinois law mostly affects nonregulated power generators in the state, the Virginia law primarily targets Dominion Energy, since the coal ash ponds cited in that law are all owned by Virginia Electric & Power Co. (VEPCO), a subsidiary of Dominion Energy. However, VEPCO's risk is mitigated by a provision in the Virginia law that permits coal ash cost pond closure recovery through a rate adjustment clause, subject to certain restrictions. That being said, we continue to monitor states with high concentrations of utility coal-fired generation (see chart 2).
Indiana is interesting because it comes second to North Carolina in terms of regulated utility ownership of unlined coal ash ponds. The Indiana Department of Environmental Management (IDEM) has historically only regulated coal ash disposed in landfills. But coal ash laws in the state were amended in 2017 to allow the Indiana Environmental Rules Board to adopt rules consistent with the federal coal ash regulations. Yet, we note that regulated electric utilities in Indiana, most notably, Nisource Inc., and Duke Energy have managed to deal with coal ash quite well.
How Do We Account For Coal Ash Risks In Our Credit Analysis?
Asset-retirement obligations (AROs) are legal obligations associated with a company's retirement of tangible long-term assets. In general, we view coal ash risks as AROs, treating this as a debt-like obligation, in line with our adjusted debt principle. We add AROs to debt after deducting any dedicated retirement-fund assets or provisions, salvage value, and anticipated tax benefits. We generally use the reported ARO figures, but we may make adjustments if we believe any of the company's assumptions are unrealistic. Those assumptions may include the ultimate cost of abandoning an asset, the timing of asset retirement, and the discount rate used to calculate the balance sheet value. In certain situations, companies fund AROs by adding a surcharge to the customer price, or the AROs will be paid by third parties such as a state-related body. In these cases there would typically be no debt adjustment. The reported accretion of an ARO is akin to noncash interest and similar to post-retirement benefit (PRB) interest charges. Accordingly, we reclassify the accretion (net of reported earnings on any dedicated ARO funds) as interest expense. This has no impact on funds from operations (FFO) since FFO is affected by cash interest as opposed to accrued interest expense.
A Few U.S. Electric Utilities Are More Exposed Than Peers To Coal Ash Risk
Duke Energy, Southern, and American Electric Power represent the top three U.S. electric utilities that are more exposed than peers to coal ash risk. As of 2018, they have a combined total of 50 unlined coal ash ponds, representing over half of the total unlined coal ash ponds owned by investor-owned electric utilities in the U.S. (see chart 3).
Duke Energy's Coal Ash Risks Are Acute
The method of coal ash pond closure is one issue. The recovery propects for such costs is another. Take South Carolina for instance. After several years of permitting coal ash cost recovery for Duke Energy the state disallowed recovery of roughly $800 million of systemwide coal ash remediation and disposal costs for Duke Energy Carolinas and Duke Energy Progress in 2019. Of these costs, 30% would have been allocated proportionately to South Carolina. This event in addition to coal ash uncertainties in North Carolina, partially led to our decision to revise Duke Energy's outlook to negative from stable in May 2019.
Despite Southern's Revised ARO Estimates, Regulatory Support For Environmental Cost Recovery Remains Strong
Our assessment of coal ash risk also takes into account the ability of companies to accurately predict the extent of costs required to close their ash ponds. For example, Southern in 2018 materially revised its ARO estimates related to CCR rules (i.e., those that largely address coal ash and related enviromental matters) to just over $4 billion, bringing its ARO liability balance to about $9.4 billion compared to an ARO balance of about $4.8 billion a year earlier. The increase stemmed primarily from feasibility studies conducted at Alabama Power Co. (APC), and a strategic assessment completed at Georgia Power Co. (GPC), both initiaives of which, are related to the parent's closure strategy of its coal ash ponds located in Alabama and Georgia. Both APC, and GPC account for roughly 90% of Southern's entire coal-fired generation fleet, or about 13,000 megawatts. Coal ash cost recovery remains strong in Alabama, where APC uses a seperate rider to recover its coal ash costs on a more timely basis. In Georgia, the Georgia Public Service Commisson (GPSC) recently approved GPC's ash pond closure strategy, which appears favorable. What is not yet clear is over what period GPC's proposed coal ash costs will be recovered, considering that GPC's request for coal ash costs recovery in the company's pending rate case represents over 50% of its overall rate case request or roughly $525 million. We view the coal ash credit risk for Southern as modest, primarily reflecting the potential for regulatory-lag in Georgia.
American Electric Power Co.'s Coal Ash Costs Will Also Likely Increase
For American Electric Power Co Inc. (AEP), because the company currently uses coal ash ponds and landfills to manage coal ash materials at its generating facilities, it expects significant costs will be incurred to upgrade or close and replace these existing facilities and conduct any required remedial actions, which we agree with. AEP's coal ash facilities are spread across multiple states, including in key states such as West Virginia, Indiana, Texas, Arkansas, and Oklahoma. In addition, the company has about 13,000 MW of coal-fired generation capacity, roughly the same as Southern's, but with fewer unlined coal ash ponds. As such, the credit impact of coal ash for AEP would primarly depend on how well the company manages its regulatory risks across more states compared to Southern, making its relative coal ash risk exposure moderately higher than Southern's.
Full Coal Ash Remediation Will Likely Take Several Years
We suspect that the process to fully remediate coal ash could entail multiple stages, including permiting, enginering, contruction, excavation, testing, and monitoring of groundwater. All of these activities take time, and may vary in complexity depending on the coal ash pond site, or pond closure strategy. All else being equal, having enough time to address coal ash risk lessens the credit impact for the affected utilities. That being said, remediation costs are based on estimates, which means that the ultimate cost to remediate coal ash can change materially, offsetting the benefit of having long-lead times to address coal ash risks. In the end, succesful execution and on-going effective regulatory risk management are critical components for credit quality to mitigate the longer-term environmental, regulatory, and financial risks for the few U.S. electric utilities that are disproportionately affected by the legacy of coal-fired generation.
Related Criteria And Research
- Criteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, April 1, 2019
- Industry Top Trends 2020: North America Regulated Utilities, Nov. 7, 2019
- U.S. And Canadian Regulatory Jurisdiction Updates And Insights: November 2019, Nov. 4, 2019
- Southern Co. full analysis, Aug. 12, 2019
- Duke Energy Corp. And Subs. Outlook Revised To Negative On Coal Ash Risks, Regulatory-Lag, And Project Delays, May 20, 2019
- ESG Industry Report Card: Power Generation, May 13, 2019
- American Electric Power full analysis, March 7, 2019
This report does not constitute a rating action.
|Primary Credit Analyst:||Obioma Ugboaja, New York + 1 (212) 438 7406;|
|Secondary Contacts:||Sloan Millman, CFA, New York + 1 (212) 438 2146;|
|Kevin M Sheridan, New York + 1 (212) 438 3022;|
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