- Credit quality for the North American regulated utility industry weakened in 2020. At the beginning of the year about 18% of the industry had a negative outlook or ratings on CreditWatch with negative implications. By the end of the year that percentage had doubled, to about 36%.
- For the first time in a decade downgrades outpaced upgrades for the predominately investment-grade industry.
- The industry generally performed well throughout the pandemic and we expect it will continue to mostly manage through the remaining COVID-19-related risks.
- The main causes of weakening credit quality reflected environment, social, and governance (ESG) risks, regulatory issues, and companies' practice of strategically managing financial measures close to their downgrade threshold with little or no cushion.
- Despite our negative 2021 industry outlook, we expect a modest improvement to credit quality over the next 12 months. We believe Congress is more likely to raise the corporate tax rate, which would improve the industry's financial measures, offset in part by a continued focus on ESG risks.
Credit Quality Weakened In 2020
We revised the industry's outlook to negative in the first quarter (COVID-19: The Outlook For North American Regulated Utilities Turns Negative, April 2, 2020), citing the already high percentage of companies with a negative outlook or ratings on CreditWatch with negative implications (18%) and the additional potential credit risks from COVID-19. During the year, the utility industry performed poorly from a credit quality perspective. The negative outlooks or CreditWatch negative listings doubled and downgrades outpaced upgrades for the first time in a decade by about 7 to 1. As a result, while the median rating for the industry remains at 'A-', it is slowly creeping closer to 'BBB+'.
COVID-19 Was Not The Culprit For Weaker Credit Quality
In March 2020, we identified five COVID-19-related risks that could lead to a weakening of the industry's credit quality. We expected that these developments could bring about a deterioration in the industry's 2020 funds from operations (FFO) to debt of about 100 basis points. These risks included the following:
- Lower deliveries to commercial and industrial (C&I) customers;
- Higher bad debt expense;
- Delayed rate case filings, delayed rate case orders, or lower-than-expected rate case outcomes;
- Lack of consistent access to the capital markets; and
- Weaker market returns that could increase postretirement benefit obligations.
Encouragingly, the industry has generally performed well throughout the pandemic. Lower electric and gas deliveries to C&I customers were mostly offset by higher residential deliveries, the industry generally worked well with regulators to defer COVID-19-related costs for future recovery, market returns improved, and the industry generally had consistent access to the capital markets. The one area that we saw some weakness was with regard to rate cases. Many rate case filings were delayed, rate case orders often took longer than expected, and many of the orders were below expectations. This trend generally reflected the weak economy caused by COVID-19 and the difficulties of passing on higher costs to customers during the pandemic. We expect that as vaccines take hold and the pandemic dissipates, the economy will gradually recover, as will the industry's rate case performance.
As vaccine rollouts in several countries continue, S&P Global Ratings believes there remains a high degree of uncertainty about the evolution of the coronavirus pandemic and its economic effects. Widespread immunization, which certain countries might achieve by midyear, will help pave the way for a return to more normal levels of social and economic activity. We use this assumption about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.
Here's What Happened
The stark weakening of credit quality in 2020 primarily reflected environmental, social, and governance (ESG) factors, regulatory issues, and the industry's practice of continuing to manage its financial measures with little or no financial cushion from the downgrade threshold.
During 2020, we saw a number of ESG-related events that included:
- A bribery charge filed against Exelon Corp.'s subsidiary (Exelon Corp. Outlook Revised To Negative On Bribery Charge; Subsidiary Commonwealth Edison Co. Downgraded, July 21, 2020).
- Unprecedented wildfire activity throughout California at the beginning of the wildfire season that could have indicated a worsening environment more susceptible to frequent wildfires. (Edison International And Subsidiary Outlooks Revised To Negative On Adverse Wildfire Conditions; 'BBB' Ratings Affirmed, Sept. 16, 2020; PG&E Corp. And Subsidiary Outlooks Revised To Negative On Adverse Wildfire Conditions; 'BB-' Ratings Affirmed; Sept. 16, 2020; San Diego Gas & Electric Co. Outlook Revised To Negative On Adverse Wildfire Conditions; 'BBB+' Rating Affirmed, Sept. 16, 2020).
- Climate change risks. Entergy New Orleans LLC Downgraded To 'BBB' From 'BBB+' On Storm Risks, Outlook Negative, Oct. 8, 2020.
- FirstEnergy Corp. terminated three executives including its CEO after it determined that they violated company policies and its code of conduct. This followed the U.S. government filing a criminal complaint against the Speaker of the Ohio House of Representatives and four associates for participating in an approximately $60 million racketeering scheme (FirstEnergy Corp. Downgraded to 'BB+' On Termination Of CEO; Ratings Remain On CreditWatch Negative, Oct. 30, 2020).
- Duke Energy Corp.'s potentially higher risks regarding its ability to fully and consistently recover coal ash costs (Duke Energy Corp. And Subsidiaries Outlooks Revised To Negative On Higher Regulatory Risks, Elevated Spending Plan, Dec. 15, 2020).
Regulatory issues also contributed to a weakening of credit quality and included the following 2020 actions:
- Puget Energy Inc. And Subsidary Ratings Placed On CreditWatch Negative Over Regulatory Concerns, July 23, 2020.
- Consolidated Edison Inc. And Subs Outlooks Revised To Negative Amid Potential Political Headwinds; Ratings Affirmed, Nov. 24, 2020.
- Following our assessment of a modest weakening of the regulatory environment in Alberta we revised our rating outlook on FortisAlberta Inc. to negative. (FortisAlberta Inc. Ratings Affirmed; Outlook Negative, Nov. 24, 2020).
During 2020, we revised the outlook on a number of companies to negative and downgraded other companies, reflecting weak financial measures.
- South Jersey Industries Inc. And Subsidiaries Outlook Revised To Negative On Weaker Financial Results; Ratings Affirmed, March 10, 2020.
- Emera Inc. And TECO Downgraded On Weak Financials, Outlook Stable; Subsidiaries Ratings Affirmed, March 24, 2020.
- ENMAX Corp. Downgraded To 'BBB-'; Off CreditWatch; Outlook Stable, March 24, 2020.
- PNM Resources Inc., Public Service Co. Of New Mexico, Texas-New Mexico Power Co. Downgraded One Notch; Outlook Stable, April 6, 2020.
- ALLETE Inc. Downgraded To 'BBB' On Expected Weaker Financial Measures; Outlook Stable, April 22, 2020.
- CenterPoint Energy Resources Corp. Ratings Affirmed On Completed Sale Of CenterPoint Energy Services, Outlook Negative, June 5, 2020.
- Otter Tail Corp. Outlook Revised To Negative; Ratings Affirmed, Aug. 18, 2020.
- National Grid North America Inc. And Subsidiaries Outlooks Revised To Negative Following Outlook Revision On Parent, Aug. 25, 2020.
- ATCO Ltd. And Canadian Utilities Ltd. Outlooks Revised To Negative; Operating Subsidiary CU Inc. Outlook Remains Stable, Sept. 17, 2020. Fortis TCI Ltd. Downgraded To 'BBB-' On Weaker Financial Measures; Outlook Stable, Oct. 21, 2020
- Middlesex Water Co. Outlook Revised To Negative On Weaker Financial Measures; 'A+' Rating Affirmed, Nov. 3, 2020.
- Unitil Corp. And Subsidiaries Outlooks Revised To Negative On Weaker Consolidated Financial Measures; Ratings Affirmed, Nov. 5, 2020.
The industry's credit quality continues to be squeezed by the industry's tendency to strategically manage financial measures with only minimal financial cushion.
What will occur in 2021?
We expect a marginal improvement in credit quality in 2021. We think it's likely that Congress will enact a higher corporate tax rate. This will help strengthen the industry's financial measures, partially offset by continued focus on ESG related risks.
Because President-elect Biden won the U.S. presidency and the democrats have control of the U.S House of Representatives and Senate, we expect Congress will more likely implement a higher corporate tax rate. While details of such a plan are limited, a key element of the proposal would likely call for an increase in the corporate tax rate to 28% from 21%. We estimate that this higher tax rate would improve the industry's funds from operations to debt by about 100 basis points (U.S. Regulated Utilities' Credit Metrics Could Strengthen Under Proposed Biden Tax Plan, Oct. 29, 2020). The improving financial measures would likely boost credit quality, enhancing utilities' financial cushions from their downgrade thresholds.
The industry's environmental risks including its exposure to greenhouse gas (GHG) emissions remain a key concern for investors. Despite the industry's enormous progress over the past decade, it has a way to go. Over the past decade, the industry significantly reduced its reliance on coal-fired generation and its associated level of carbon based emissions. The industry is no longer the number one North American emitter of carbon-based pollutants, reducing its carbon emissions by about 25% and has reduced its reliance on coal-fired generation by about 50%.
Still, about 30% of the electric utility industry relies on coal-fired generation for at least 50% of its owned electricity production and about two-thirds of those utilities depend on coal-fired generation for more than 70% of their total generation. Investors are increasingly focused on environmental issues and given that the industry typically operates with negative discretionary cash flow, it relies on consistent access to reasonably priced capital markets. We expect that the continued focus on these ESG risks will weaken credit quality, offsetting much of the credit benefits from a potentially higher corporate tax rate.
This report does not constitute a rating action.
|Primary Credit Analyst:||Gabe Grosberg, New York + 1 (212) 438 6043;|
|Secondary Contacts:||Daria Babitsch, New York 917-574-4573;|
|Daniel Bairbekov, New York + 212-438-1903;|
|Minni Zhang, New York;|
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