Although U.S. public power and electric cooperative utilities face the specter of significant credit disruptors in 2020, we expect to see resilient and generally stable ratings. Electric utilities are benefiting from a predictable pathway for recovering costs, whether through autonomous or regulated ratemaking. Furthermore, the moderately growing economy and its low interest rates and natural gas prices is tempering pressures on income statements and balance sheets in this capital intensive industry.
S&P Global Ratings projects that ratings for public power and electric cooperative utilities will remain concentrated in the 'A' rating category in 2020 (see charts 1 and 2). We base our view on these not-for-profit utilities' generally strong financial and enterprise profiles. We believe their financial performance reflects resilience in the face of increasingly stringent power plant emissions regulations and the emergence of technologies that could disrupt the traditional electric utility central station business model.
What We Are Watching
In 2020, to preserve credit quality, public power and electric cooperative utilities will need to continue to respond to:
- Evolving environmental regulations that might devalue investments in conventional generation resources;
- Technological developments that might erode demand for central station power; and
- Natural forces such as climate change that can impair system reliability and give rise to liability claims.
Just the same, we foresee a stable outlook for the sector. We premise our conclusion on the capacity of public power and electric cooperative utilities to perpetuate resilience. We anticipate that they will adjust rates with an eye toward recovering the operating and capital costs associated with complying with emissions regulations, capture fuel price volatility in rates, and maintain affordability and preserve sound financial margins.
Erratic environmental regulations have whipsawed utilities' generation resource strategies. In just a few years, the focus of management teams has shifted from preparing to respond to the stringent federal Clean Power Plan (CPP) to adapting to the varying stringencies of state and regional regulations. Coincident with the federal government supplanting the CPP with the more liberal Affordable Clean Energy Rule, many state and local jurisdictions are pressing ahead with climate change regulations and legislation in response to pressure from constituents to reduce power plant's greenhouse gas and particulate emissions. Many of these state and local bodies are acting to fill the void they perceive in federal policy. As non-federal initiatives advance, it is becoming increasingly difficult and costly to position utilities for the future, particularly when the goalpost keeps moving.
Adding to the uncertainty is the run-up to the 2020 presidential election. The incumbent plans to stay the course of a light regulatory touch. Some opposing candidates pledge that they will dramatically clamp down on sources of greenhouse gas emissions. Their proposals include supplanting carbon-based electric generation with renewable resources and banning fracking that has yielded historically low input prices for electricity production. Implementing these scenarios might upend the electric utility industry and lead to significantly higher electric prices for consumers if utilities are to preserve their financial metrics and their credit ratings.
We believe there is a mismatch between current technologies and the ability to realize some aspirational climate goals. This mismatch can saddle utilities with financial and operational burdens if utilities must replace conventional resources with renewable resources. Because many conventional resources are unable to ramp up and down as the wind and sunlight wax and wane throughout the day, integrating intermittent resources is also challenging. In addition, ramping adds to wear and tear and maintenance costs. The costs of environmental mandates task utilities with balancing retail rate affordability and financial integrity. Utilities also are contending with technologies that are whittling the demand for the central station power they produce and frustrating the efficient allocation of fixed costs among all customers. These emerging technologies include rooftop solar panels and more energy efficient appliances and lighting.
Among the public power utilities and electric cooperative utilities we rate, we generally observe that management is meeting these challenges. Their strategies include redesigning retail rates to reallocate more fixed costs to base charges to facilitate more certain fixed cost recovery from customers that are purchasing less energy from the utility but that are nevertheless relying on grid connectivity for reliability. However, one utility, Florida's JEA, concluded in July that it needed to explore privatization in response to the threat of customers migrating to rooftop solar panels and other technological innovations that might eviscerate its revenue stream. Management predicted that technological developments and the constraints of its business model would create a need for sizable and potentially burdensome rate increases over the long term. Yet JEA abandoned its privatization strategy in December, in response to negative perceptions of its process for soliciting privatization bids and Jacksonville's reassessment of the utility's vulnerability.
Getting out over their skis?
About one-fifth of U.S. states have directed electric utilities operating within their borders to eliminate carbon-based generation by 2040 or 2045. For example, in July 2019, New York State enacted the Climate Leadership and Community Protection Act. The legislation's far-reaching provisions include a directive that 70% of the state's electricity come from renewable resources by 2030 and 100% of the state's electric sector's production be free of greenhouse gas emissions by 2040. The legislation also contemplates reaching three gigawatts of statewide energy storage capacity by 2030.
We view carbon-free dictates like those in New York and California as laudable, but also ambitious. We believe these goals have the potential to add costs and present operational exposures because of technological and operational limitations. For instance, extant storage technologies have limited ability to counter the intermittency of wind and solar resources. Many cite battery technology as a solution. Yet, battery technology represents a nominal percent of installed capacity in the U.S. and is insufficient to counter intermittency meaningfully (see chart 3) Moreover, existing battery installations paired with intermittent resources only provide a few hours of coverage for gaps in production.
The economics of battery investments remains questionable. Anyone owning a cell phone knows that lithium ion batteries can only support a finite number of charging cycles. Utility-scale storage principally uses lithium ion technology, albeit on a much larger scale. The lifespan of utility battery banks is uncertain. The technology is too new to gauge the effects of numerous charging and discharging cycles on batteries' long-term viability. The specter of replacement costs for battery banks and the disposal costs for exhausted batteries represents another challenge for utilities facing state carbon-reduction mandates.
Yet, consider that July 2019 marked the 50th anniversary of the first lunar landing, a feat achieved because NASA and private sector engineers took up the challenge of innovating in an unprecedented and expeditious effort in support of President John F. Kennedy's goals. In May 1961, when President Kennedy implored Congress to fund a mission to put men on the moon by the end of the decade, many questioned the viability of his proposal because the technologies to accomplish such a mission simply did not exist.
For today's electric utility sector, the possibility exists that regulatory and legislative pressures will spur technological innovations in storage technologies. If they succeed in advancing resources that complement wind and solar resources, the laudable goals of achieving carbon-free electricity might become a reality by the target dates.
It is notable that the space program encountered very substantial cost overruns in developing the hardware and software that supported lunar missions. If the same holds true for the power sector, credit quality might suffer if customers are unwilling or unable to shoulder the potentially burdensome costs of migrating to carbon-free generation fleets.
Seamlessly translating laudable aspirations into practical applications can be at odds with stable credit quality. The drive to embrace renewable resources, claim carbon independence and tout sustainability can yield unintended negative consequences. In May 2019, S&P Global Ratings lowered the long-term rating on the Georgetown, Texas municipal utility system's revenue bonds to 'AA-' from 'AA'. Our downgrade reflected the financial losses the utility incurred in connection with power purchase agreements (PPA) among the city and renewable resource generation developers.
The city entered into the PPAs as part of its strategy to secure a quantity of renewable energy commensurate with 100% of its retail customers' annual electricity consumption. However, because of a mismatch between the hours in which renewable generation resources produce power and the hours in which retail customers consume electricity, the substantial renewable purchase obligations compelled the city to sell in the competitive ERCOT marketplace about 46% of its contracted renewable purchases. The utility is a price taker when it sells its surpluses and the sales are frequently at prices below the cost at which Georgetown procures the contracted renewable energy. Georgetown faces low market prices because, in Texas, there is an abundance of gas-fired electricity and renewable electricity production. This abundance depresses ERCOT power prices to levels that are below those at which Georgetown procures its contracted power.
During hours that the renewable resources that Georgetown contracted are not producing electricity, the city procures market power, which includes the output from conventional, carbon-based resources. We observe that other municipal utilities cite Georgetown's experience as instructive as they position their utilities to become more environmentally friendly.
California: the leader as victim
Climate change is negatively affecting California's electric utilities more than other states' utilities. The multi-billion dollar bankruptcy of Pacific Gas and Electric Co. (PG&E) provides the most salient example of the personal and financial toll of wildfires attributable to persistent drought conditions and poor asset stewardship. The pronounced effects of climate change on California's electric utilities stands in sharp contrast to the state's numerous and groundbreaking initiatives to combat climate change, including renewable mandates, green building codes, and a moratorium on extending existing PPAs with coal-fired generation facilities.
California plaintiffs rely on the state constitution's inverse condemnation doctrine in support of their large liability claims against electric utilities for wildfire damage. The inverse condemnation doctrine provides that if a state actor or a company serving the public is the substantial cause of property destruction, it can be liable for damages to affected property owners. The doctrine is equally applicable to investor-owned and publicly owned utilities and negligence is not a precondition to liability. We believe that the prospects for legislatively limiting the scope of the inverse condemnation doctrine are slim because the electorate is likely to take a dim view of actions that compromise property rights.
Several of the state's public power utilities cite underground wires and urban density as mitigating their wildfire exposure. Although we see merit in these claims, we nevertheless believe these attributes do not cloak utilities with an impenetrable shield. For example, the Los Angeles Department of Water and Power (LADWP) cites its largely urban and dense service territory as limiting its exposure to wildfires, particularly when compared with the significantly more rural PG&E and Southern California Edison utilities (see charts 4 and 5).
Nevertheless, fire officials attribute to LADWP's utility assets three major fires in recent years. We reflected the utility's exposures to wildfires and the potential for financial liability by placing the utility on CreditWatch with negative implications in November 2019.
We view the autonomous rate-setting authority available to public power utilities as providing latitude, within limits, to recover liability costs from their ratepayers and socialize damage assessments among ratepayers. We consider public power utilities as better able to recover liability costs than their investor-owned utility (IOU) counterparts because the IOUs lack autonomous ratemaking authority and are subject to regulatory oversight. Rate oversight has led to disallowances and delayed recovery for IOUs. Yet, we do not view public power utilities' autonomous ratemaking authority as an absolute shield. The magnitude of claims, the effects on rates, and the availability of insurance and liquidity determine the extent of insulation. For example, in March, we lowered the ratings on the Trinity Public Utilities District to 'A-' from 'AA-'and placed the ratings on CreditWatch with negative implications to reflect the potential that fire claims could exhaust its liquidity, insurance coverage and ratemaking flexibility.
Although they are not facing wildfire claims, we have assigned negative outlooks to the Sacramento Municipal Utility District, Glendale's municipal electric utility and the Transmission Agency of Northern California to reflect our assessment of these utilities' vulnerability to wildfires. We based our conclusions on the topography of the utilities' service territories and the California Public Utilities Commission's identification of portions of their service areas as lying within elevated fire risk zones.
S&P Global Ratings is reviewing the fire mitigation plans California's public power utilities filed with the state in late December to comply with a legislative mandate. If the review identifies public power utilities that are likely to face wildfires and potential liability claims that could exhaust their ratemaking capacity, insurance limits, and liquidity, negative rating actions would follow. Our assessment is also evaluating the effects of mitigation plans on retail rates and ratemaking flexibility as utilities incur costs for cladding miles of transmission lines with insulating material to prevent sparking and replace wooden poles with fire-resistant steel. In addition, because the PG&E bankruptcy emphasizes that good asset stewardship is critical to public safety, we are assessing public power utilities' infrastructure management to identify emerging exposures.
Stakeholders in the PG&E bankruptcy proceedings are proffering competing reorganization plans for the utility. In addition to plans proposed by the company and investors, the state and a number of municipal entities are proposing acquiring all or portions of the PG&E system. In support of their proposals, they assert that public ownership and accountability will provide a pathway to more reliable and safer electric service, along with favorable retail rates. It is uncertain whether the governmental overtures will pass muster in the bankruptcy court. We expect the court to approve a reorganization plan that equitably addresses the claims of all stakeholders. If one or several of the governmental units seeking to succeed PG&E should prevail, we will assess their credit quality with a focus on the acquirer's exposure to costs of rehabilitating neglected PG&E assets, added susceptibility to wildfires through the acquisition and the related potential for inverse condemnation liability.
The siren call of wholesale markets
Over many years, municipal and distribution cooperative utilities banded together to form joint action agencies and generation and transmission cooperatives to construct and finance electric generation projects that could provide economies of scale and resource diversity that they could not achieve on their own due to the size of the individual participants. This partnership model has been a hallmark of U.S. not-for-profit utilities. However, more recently, as low natural gas prices and an abundance of wind and solar resources have depressed electricity prices in competitive wholesale markets, we observe that some municipal and cooperative utilities are questioning their long-term obligations to their wholesale suppliers. In the last few years, participants in joint projects have sought buyouts or have elected not to renew expiring power purchase commitments so that they can supplant their incumbent provider with market purchases. The departure of some members of Tri-State Generation and Transmission Association and overtures by other members who are seeking alternative power supply opportunities triggered our downgrade of the cooperative's rating to 'A-' from 'A' with a negative outlook to reflect the possibility that the utility will need to look to a smaller base to recoup costs. Overall, the numbers remain modest, but the trend appears to be gaining traction. We are monitoring these developments for contagion risk. Some additional examples of member discord or dissatisfaction include:
- Nebraska Public Power District participants that opted to sever their relationship with the wholesale utility.
- Memphis Power and Light's ongoing exploration of alternatives to purchasing its electricity from the Tennessee Valley Authority.
- Bonneville Power Authority's strategic efforts to avert departures when its customer contracts expire in 2028.
We are monitoring these trends to assess the potential for departures to shift costs to remaining customers and potentially eroding project economics and affordability. We are also examining the effects of cost shifting on remaining participants' financial performance because a wholesaler's credit quality is dependent on the cash flows from its purchasers.
The growing threat of cyberattacks
In November, the Wall Street Journal identified more than a dozen U.S. electric utilities targeted by cyber attackers. Recent threats from state actors in the Middle East add to the specter of cyberattacks on electric systems.
Crippling the grid could have far-reaching implications. It would not be just about disrupting utility revenue streams and cities coming to a dark standstill; commerce would stop as well. The potential spillover disruption is extensive. These vulnerabilities make the seemingly endless supply of electricity that we perhaps take for granted an attractive target. Efforts to avert cyberattacks place demands on utilities resources. Consequently, we continue to assess utilities' preparedness as well as the potential costs.
Shock absorbers supporting rating stability
Against the backdrop of disruptive regulations and technologies and the effects of climate change, S&P Global Ratings believes that not-for-profit public power and electric cooperative utilities, for the most part, have the potential to sustain the strong ratings we assign. We believe that the ratemaking construct provides a predictable pathway for recovering costs. These capital-intensive utilities are also benefitting from years of low interest rates that mitigate borrowing costs. The participants in Georgia's Vogtle nuclear project cite lower than expected borrowing costs as helping temper the delayed project's substantial cost overruns.
A decade of low natural gas prices and expectations that this trend will likely continue provides electric utilities with low prices for a key input and headroom for absorbing the costs of capital investments and complying with evolving environmental regulations. The availability of low natural gas prices and favorable wholesale market electricity prices allows utilities to pass along to customers, non-fuel costs without overly burdening retail rates and exhausting financial flexibility.
When thinking of industrial companies, a strong and growing economy typically presages financial strength. For electric cooperative and public power utilities, we have a different perspective. A rapidly expanding economy can necessitate large generation investments to support growth. Generation additions can also burden balance sheets and depress debt service coverage metrics, unless utilities implement proportional rate increases. Generation does not lend itself to incremental additions because larger units provide economies of scale that small units do not.
The U.S. economy has been growing at a tepid pace for many years. S&P Global Economics projects this trend will continue. (see table). Consequently, we have observed that the diminished contribution of generation investments relative to transmission and distribution spending has helped preserve credit quality.
|S&P Global Economics Projection Of Annual Real GDP|
|2018 actual||2019 forecast||2020 forecast||2021 forecast|
|Real GDP growth (%)||2.9||2.3||1.9||1.8|
|Source: S&P Global Economics. See "Fewer Signs Of Scrooge-ing Up U.S. Growth In The New Year," Dec. 4, 2019.|
This report does not constitute a rating action.
|Primary Credit Analyst:||David N Bodek, New York (1) 212-438-7969;|
|Secondary Contacts:||Jenny Poree, San Francisco (1) 415-371-5044;|
|Paul J Dyson, San Francisco (1) 415-371-5079;|
|Jeffrey M Panger, New York (1) 212-438-2076;|
|Scott W Sagen, New York (1) 212-438-0272;|
|Doug Snider, Centennial + 1 (303) 721 4709;|
|Alan B Shabatay, New York + 1 (212) 438 9025;|
|Timothy P Meernik, Centennial + 1 (303) 721 4786;|
|Stephanie Linnet, Centennial + 1 (303) 721 4393;|
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