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ESG Brief: Emerging Themes In U.S. Public Finance

As the health and safety crisis resulting from the pandemic wanes in the U.S., S&P Global Ratings believes U.S. public finance (USPF) issuers will face challenges adapting to a rapidly evolving environmental, social, and governance (ESG) landscape while adjusting to a sharp shift in federal policies under the Biden administration. We believe these issues will shape emerging risks or opportunities with the potential to alter USPF issuers' credit fundamentals. In this inaugural ESG Brief, we provide an overview of these themes and examples of forward-looking analytical considerations.

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Energy Transition Risk

One of the first orders of business under the Biden administration was rejoining the Paris Agreement, the international treaty on climate change within the United Nations Framework on Climate Change, which also led to reinstitution of a slew of emissions standards in the U.S. In April 2021, President Biden announced a new target for the U.S.: a 50%-52% reduction in economywide net greenhouse gas pollution from 2005 levels by 2030. We believe that Biden's plan, if implemented, and a broader trend toward net-zero emissions policy will intensify transition risk for utilities and state and local economies concentrated in energy production. Furthermore, for some USPF sectors, particularly those with a large physical footprint and high energy use, investments in capital and operating initiatives may be required to adapt to changing climate-related regulations. Chart 1 shows the evolution of fuel sources in U.S. electricity production over the past 10 years, with coal falling as the regulatory framework has changed, natural gas prices have declined, and renewable energy sources have ramped up. Although many public power utilities and investor-owned utilities have committed to significantly reducing greenhouse gas emissions over time to advance environmental goals or comply with state directives, the amount of energy generated with renewable sources will need to double to soak up the 20% of electricity generation still produced with coal. While we believe renewable sources will continue increasing as a share of fuel production, the trajectory may slow until a technology solution facilitates integration into generation fleets through storage capacity that reduces intermittency that could compromise electric service reliability. Positively, the Biden administration's proposed American Jobs Plan could help offset transition infrastructure costs or provide employment opportunities for individuals displaced by energy transition initiatives.

Chart 1

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Social Justice

Social justice encompasses a wide umbrella of policy issues confronting USPF issuers, such as increasing scrutiny of policing practices; prioritization of resources to bridge the racial, income, and health equity gaps within a community; ensuring that low-income areas are not disproportionately exposed to environmental risks such as inland flooding; and federal changes to immigration policy. S&P Global Ratings has always considered the community's relationship with the government or other not-for-profit service provider through authorization of voter initiatives, support of property tax or user rate changes, and how turnover in elected board positions may affect policies and practices. However, the murder of George Floyd and other events across the U.S. have brought into greater focus an issuer's response to the community's engagement on racial issues. In addition, we believe the Biden administration's change to immigration policy, including the Deferred Action for Childhood Arrivals, could require additional services but support demographic growth in areas that rely on international mobility or migrant labor to generate job and economic expansion. For instance, chart 2 shows net international migration over the past 20 years, including the period under the Trump administration, when more restrictive policy curtailed these trends. The sharp decline in 2020 likely reflects the effect of the pandemic, but international migration has been declining since 2016.

Chart 2

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Acute Physical Risks

The National Oceanic and Atmospheric Administration recently released a set of climate averages covering the 30-year period from 1991 to 2020 showing that the climate has turned warmer--with the average temperature for the 48 contiguous states climbing to a record 53-plus degrees Fahrenheit (up 1.7 degrees since 1901 to 1930, the first period for which climate normals were calculated). Although this may not sound significant, it represents an average warming across the states, with some regions recording higher temperatures than others. For example, the increase observed in Alaska indicates that Fairbanks is no longer a sub-Arctic climate but resides within a warm summer continental zone. Similarly, on May 12, 2021, the Environmental Protection Agency updated data sets that contribute to its National Climate Assessment, adding indicators that track the physical changes of warming temperatures and the effects on natural disasters and resident populations. We believe USPF issuers face greater frequency and severity of acute physical risks, including hurricanes, droughts, wildfires stemming from climate change, and heat waves. Studies show that heat waves can reduce worker productivity, particularly for outdoor workers but also office workers, and can increase electricity prices as demand rises and production efficiency drops. Although these risks vary by region--for example, with wildfires concentrated in the West and Southwest (see chart 3)--credit stability will require increased efforts to bolster infrastructure and finances against these events.

Chart 3

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Risk Management Strategies

S&P Global Ratings incorporates financial and operational management, or management and governance analysis within each of its USPF practice-level criteria. We believe positive elements of comprehensive risk management include long-term planning efforts that guide decision-making, and adherence to stated reserve and liquidity policy thresholds to insulate operations from unforeseen events. However, as emerging risks crystalize, we believe risk management efforts will evolve. This is evident in an enhanced wildfire analysis with California utilities and in management discussions on cybersecurity, particularly with such attacks accelerating with more sophisticated bad actors that include threats to community health and safety. We also believe the pandemic represents a disruption requiring management teams to consider other emerging risks that may require establishing dedicated reserves, equipment stockpiles or replacement (e.g. to electric vehicles), or operational changes (e.g. personnel positions to oversee diversity, equity, and inclusion initiatives).

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Transparency And Disclosure

In 2017, as a result of the large-scale and complex nature of climate change, the Task Force for Climate-Related Financial Disclosure released climate-related financial disclosure recommendations focusing on corporate entities. We believe the framework could help inform a similar disclosure regime for public finance issuers, and recently the Government Finance Officers Assn. published "Best Practices for ESG Disclosure" as a guide for issuers to assist with increasing transparency of environmental risks. Furthermore, the State of California is initiating efforts to implement statutory provisions to require better and uniform disclosure on climate change risks, and President Biden's executive order on climate-related disclosure requirements and standards will likely advance transparency initiatives. In our view, market participants would benefit from more robust disclosure tailored to an issuer's specific risk exposure that increases transparency and presents an opportunity for issuers to demonstrate the benefits of existing or planned adaptation actions.

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This report does not constitute a rating action.

Related Research

Primary Credit Analyst:Nora G Wittstruck, New York + (212) 438-8589;
nora.wittstruck@spglobal.com
Secondary Contact:Kurt E Forsgren, Boston + 1 (617) 530 8308;
kurt.forsgren@spglobal.com
Research Contributor:Adriana Artola, Research Contributor, San Francisco + 415-371-5057;
Adriana.Artola@spglobal.com

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