Sector View: Stable
We expect most of the sector's ratings to remain stable in 2021. Nearly all the sector's utilities are displaying resilience in the face of the pandemic's disruptions. We expect low prices for natural gas, and cost cutting measures, will continue to temper the financial pressures on the economy and electric sales. Nevertheless, we recognize that financial performance and credit ratings could be pressured, particularly at utilities that rely on electric revenues from customers hardest hit by the pandemic, such as businesses engaged, and residential ratepayers employed, in the hospitality and travel industries, or utilities required to make transfer payments to offset declines in municipal tax revenues.
Questions That Matter
1. What will the pandemic mean for public power and electric cooperative utilities in 2021?
How this will shape 2021
The recent rollout of COVID-19 vaccines is a very encouraging development in the efforts to contain a virus that has plagued the U.S. for nearly a year. The vaccine appears to be a vehicle for the economy to reclaim lost ground and facilitate the financial capacity of utilities' business and residential ratepayers to more universally pay their bills in a timely manner.
What we think and why
Because of electricity's essentiality, we believe the financial performance and ratings of only a subset of the public power and electric cooperative sector is vulnerable to the pandemic's economic pressures. We view the ratings of public power and electric cooperative utilities to be most vulnerable among those utilities whose electricity sales are sensitive to social distancing and travel restrictions, which our rating actions reflected when we assigned a negative outlook to California's Anaheim Public Utilities and lowered the rating and assigned a negative outlook to Florida's Reedy Creek Improvement District. These two utilities have sizable exposures to travel and tourism-related retail customers that operate large theme parks and related properties. By comparison, few other public power and electric cooperative utilities that we rate have travel and tourism related dependencies approximating those of Anaheim and Reedy Creek. In addition, we rate many rural utilities that are not nearly as exposed to economic dislocations as their more urban counterparts. Generally, while suspensions of economic activity in the commercial and industrial sectors due to health and safety considerations have moderately whittled energy sales and revenues at many utilities, we observe that the disruptions and the revenue losses have not reached levels that erode these utilities' ratings.
The effectiveness of measures to contain the virus could determine the susceptibility of a broader group of public power and electric cooperative utilities to financial pressures in 2021. The logistics of delivering the vaccine to millions of Americans are very complicated and it is increasingly apparent that it will take time to achieve herd immunity and rehabilitate the economy to year-end 2019 levels. A cohort that resists vaccination could aggravate efforts to achieve economic recovery.
We are monitoring the extent to which the pandemic's burgeoning second wave is renewing economic disruptions and whether the resulting unemployment and business closures have the potential to impair the revenue streams of public power and electric cooperative utilities. On the heels of a bruising 3.9% GDP decline in 2020, our economists' baseline forecast projects U.S. GDP will not recover to year-end 2019 levels until 2021's third quarter, and unemployment, not until late 2023, or possibly later (see chart 1).
So far, moratoriums on service disconnections for nonpayment have not be problematic. Legislative and regulatory mandates and utilities' self-imposed restrictions barring electric service disconnections for nonpayment, have the potential to frustrate timely cost recovery and erode liquidity. Yet, while many utilities are reporting that delinquent account balances rose in 2020 relative to recent years, they also report that the dollar magnitude of the increases have been inconsequential relative to their overall revenue streams.
2. What will Biden energy policies mean for public power and electric cooperative utilities in 2021?
We think public power and electric cooperatives' credit ratings might be vulnerable to more stringent and costly environmental regulations in 2021 and beyond.
How this will shape 2021
We expect more stringent environmental regulations that will likely to add to capital and operating costs. S&P Global Ratings expects the Biden Administration to pursue tightening environmental regulations governing the electric industry and its fuels. Such measures could directly and indirectly affect public power and electric cooperative utilities' operations, their costs of doing business, retail rates, their financial flexibility, and possibly their ratings. Ultimately, whether the new administration's environmental policies will affect our ratings will depend on how much of the campaign platform translates into new regulations and legislation, its costs, and the time required for compliance with more stringent regulations.
What we think and why
We view natural gas prices as particularly susceptible to upward pressure. If a Biden administration directly or indirectly restrains fracking, natural gas prices could rise sharply. Natural gas is the primary input for producing electricity in the U.S. (chart 2). Consequently, limiting natural gas production could lead to higher electricity production costs and retail prices that consumers pay for electricity. Low natural gas prices played a significant role in shoring up the financial performance of public power and electric cooperative utilities in 2020, at a time that many utilities concluded that the economic environment was not conducive to raising retail service charges, whether due to the inability of customers to shoulder rate increases or the negative optics of raising rates in a recessionary environment. Restrictions on drilling for natural gas that propel a need for higher retail electricity rates could unravel the benefits of the low gas prices that inured to utilities at a time that the pandemic era places limits on utilities' financial flexibility.
Rate affordability and consumer acceptance place limits on the rates utilities charge for essential electric service and negatively affect financial performance and operations. We believe higher electricity production costs due to natural gas prices could erode financial margins and ratings because rate affordability plays an important role in influencing public power and electric cooperative utilities' credit ratings. Consumers are sensitive to the level of their utilities' service charges, which is a factor that can limit ratemaking capacity. Therefore, it is possible that spending for environmental compliance costs could come at the expense of investments in the reliability and safety of the electric grid.
Transitioning to clean energy might not be as effortless as its proponents suggest. In recent years, many state initiatives for reducing carbon emissions, other greenhouse gas emissions, and the solid byproducts of electricity production, emphasized utilities transitioning to wind and solar resources. Some of the more ambitious of these initiatives appear to discount the intermittency of renewable generation and the insufficiency of existing electricity storage technologies to counter intermittency. Neither solar nor wind produce electricity around the clock and current technologies do not provide capacity to store enough of the surplus solar and wind electricity produced during peak production hours to cover the nonproduction hours and could lead to less reliable electric service (see "California's Rolling Blackouts Could Foreshadow Rating Pressures For Public Power And Electric Cooperative Utilities," Sept. 10, 2020). Federal initiatives that build on state initiatives and that do not appropriately account for intermittency and storage issues could face similar pitfalls.
We expect the trend of significant coal plant closures seen in recent years to continue during Biden's presidency. If public power and electric cooperative utilities are compelled to close undepreciated power plants, utilities' financial performance could face pressures. Although public power and electric cooperative utilities can look to their essentially captive customer bases to recoup uncompensated investments, this could be financially burdensome to customers, particularly if these utilities need to secure alternative sources of electricity production that add costs.
3. Will ESG factors influence credit views in 2021?
Each of the ESG factors carries considerable weight in our consideration of their applicability to public power and electric cooperative utilities. The emissions and byproducts of electricity production influence environmental considerations. The affordability of rates and the financial flexibility available to utilities are important social considerations. Lastly, the ability of management and boards to respond to fluid regulatory and economic environments are integral to a utility's viability. We view public power and electric cooperative utilities' ESG performance as influencing their ability to attract capital, the willingness of their counterparties to enter into bilateral contracts with them to provide essential commodities and insurance, and the capacity of utilities to attract employees of the highest caliber.
If capital-intensive utilities are unable to attract capital, they face uncertain prospects for long-term economic viability, given the enormity of the costs of building generation and transmission projects, which could negatively affect ratings.
How this will shape 2021
We expect environmental remediation efforts to take on added significance in 2021. Many of the public power and electric cooperative utilities that we rate exhibit high levels of carbon intensity that can constrain ratings. We view the specter of significant environmental compliance and remediation costs that carbon-intensity presents as constraining and possibly negatively pressuring ratings. In addition to the costs of securing replacement generation, having to shutter noncompliant generation resources or remediate coal ash ponds might impair operations.
What we think and why
On a positive note, we have observed that many public power and electric cooperative utilities are committing to significantly remaking their generation portfolios to reduce long-standing, high levels of carbon intensity. Examples include Minnesota's Great River Energy, Colorado's Tri-State Generation, and Arizona's Salt River Project.
Great River Energy's "Phoenix Project" will retire nearly 1,200 megawatts of coal-fired capacity at its Coal Creek Station by the end of 2022. The utility will also convert its Spiritwood Station to natural gas and add significant wind purchases. Tri-State Generation announced its "Responsible Energy Plan" that accelerates the retirements of coal capacity at Craig Generating Station units and, also the Escalante station. Like Great River Energy, Tri-State plans to add significant renewable resources to offset some of the capacity retirements. Great River and Tri-State expect that their plans have the potential to reduce costs, but that view is not consistent across the utility space. Salt River Project is developing the specifics of its "2035 Sustainability Plan Framework," that commits the utility to reducing the amount of carbon dioxide it emits per megawatt-hour of electricity production by 62% relative to 2005 levels by 2035 and by 90% by 2050. The sustainability plan also commits the utility to reducing its generation-related water use by 20%.
The economic climate adds to the potential for social factors to influence ratings. The social component of ESG has many more facets than ESG's environmental component. Social factors include, among others, rate affordability, the health and safety of communities proximate to power lines and power plants emissions, the health and safety of the work force, gender equality in the workplace, and nondiscrimination policies.
For electric utilities, S&P Global Ratings considers each of the preceding factors, with particular emphasis on how compliance with environmental regulations will influence retail rates and their affordability. A lack of affordability can constrain a utility's ratemaking flexibility and its ability to recover increasing costs. Rate affordability also speaks to the ability of low to moderate income customers to procure electric service that is essential to their health and safety.
We believe the negative economic pressures flowing from the pandemic could frustrate the ability of consumers to absorb environmental compliance costs and adversely affect ratings at some public power and electric cooperative utilities.
The uncertain regulatory and economic environment underscores the role of strong governance. For public power and electric cooperative utilities, we view the exploration of the governance element of ESG as an appraisal of management's ability to successfully navigate a fluid landscape of environmental regulations and adverse economic conditions while sustaining strong customer relations. We believe that for public power and electric cooperative utilities to remain financially viable, management teams need to be able to adapt to changes in a constructive manner that sustains long-term financial and operational viability without estranging customers.
As noted, we view favorably the actions by utilities like Great River Energy, Tri-State Generation, and Salt River Project, to remake their generation fleets to reduce their carbon footprints both to meet regulatory mandates and to satisfy their customers' desire to consume clean energy.
A utility's ratemaking framework is another important component of our governance assessment. Most of the public power and electric cooperative utilities we follow have autonomous ratemaking authority that facilitates nimble responses to changing circumstances. We view utilities that have formulaic, non-discretionary pass-through mechanisms as possessing a tool that adds to the financial flexibility that autonomous ratemaking provides by removing some governance risk.
We also have a favorable view of most rate-regulated public power and electric cooperative utilities. We base this view on regulators' legal obligation to provide for the recovery of prudently incurred costs, plus a return. However, we have seen at Tri-State Generation that members can and will use regulatory oversight as a sword to challenge ratemaking decisions, where possible, which contributed to our negative rating actions on the utility.
The nation's weak economic environment tasks utility management with a difficult balancing act. In this period when the country is experiencing the severe economic fallout flowing from the COVID pandemic, we believe utility management teams face the difficult task of reconciling:
- The negative social considerations of possibly forcing large numbers of customers into darkness for nonpayment; and,
- The alternative, the financial morass utilities could face if they accommodate financially challenged customers by providing uncompensated service that erodes utility cash flows and liquidity.
We are monitoring how utilities are responding to these challenges, especially as the pandemic and a weak economy drag on and ratepayers are left to make difficult decisions about how to allocate their finite financial resources. Yet, as noted, public power and electric cooperative utilities continue to report that the level of delinquent payments remains moderate relative to their overall operations.
4. What legal risk do California's public power utilities face from wildfire liability claims?
How this will shape 2021
California wildfires have grown in intensity, size, and frequency over the past several years. Wildfire risk is particularly heightened in California because, under California law, courts can apply the doctrine of "inverse condemnation" to both investor owned utilities and public power utilities. The doctrine provides that if a state actor or a company providing services to the public, like an electric utility, is the substantial cause of property destruction, whether or not through negligence, it can be held liable for damages to affected property owners (see "California Public Power Utilities Face Disparate Physical and Credit Exposures to Wildfires," Aug. 4, 2020).
What we think and why
We believe that California municipal electric utilities are generally less exposed to wildfire risk than the large investor-owned utilities in the state. Our view is based on the municipal utilities' small geographic footprints and location in largely urban, low fire threat zones. The state's public power utilities also do not need regulatory approval to raise rates or issue debt to fund claims to the extent they are liable for wildfire-related liabilities resulting from the application of inverse condemnation. However, we have identified material wildfire exposures for three municipal utilities that led to rating downgrades in 2019 and 2020, including Trinity Public Utilities District (now BBB+/Stable, lowered from AA-/Stable), Los Angeles Department of Water and Power's power system (AA-/Negative, lowered from AA/Stable) and Glendale Water and Power's power system (A+/Stable, lowered from AA-/Stable).
Although we believe California's public power utilities generally have a more moderate exposure to wildfire claims than their investor-owned counterparts, they are not immune and the growing difficulty in obtaining affordable wildfire liability insurance exacerbates credit exposures. We continue to focus on the topography of utilities' service territories, and efforts to prevent or contain wildfires. Where insurance is too costly or unavailable, we believe utilities will face higher financial risks. We note that most utilities, particularly those with meaningful wildfire risk, de-energize lines when high wildfire threat conditions exist. At the same time, we understand that the decision to de-energize lines can sometimes be difficult from a political and/or reliability standpoint; nonetheless, we believe the benefits could often far exceed the costs and result in the avoidance of significant wildfire claims, including loss of life.
Rating And Outlook Distribution
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;|
|Jeffrey M Panger, New York + 1 (212) 438 2076;|
|Paul J Dyson, San Francisco + 1 (415) 371 5079;|
|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 + 303-721-4393;|
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