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For Investor-Owned Utilities, Winter Storm Uri Hasn't Yet Affected Our View Of Texas' Regulatory Framework

S&P Global Ratings considers the regulatory framework for electric utilities under the Public Utilities Commission of Texas (PUCT) to be mostly predictable and stable. This includes investor-owned transmission and distribution (T&D) utilities operating within Electric Reliability Council of Texas (ERCOT) and investor-owned vertically integrated utilities (VIUs) operating outside of ERCOT. As a result, we view the PUCT regulatory jurisdiction as very credit supportive. We evaluate jurisdictions by the qualitative and quantitative factors that affect the regulatory advantage for the utilities we rate. We view the regulatory assessment as the single most important factor in assessing a regulated utility's competitive position (see "Key Credit Factors For The Regulated Utilities Industry," Nov. 19, 2013).

Key Factors Of The PUCT's Electricity Regulatory Framework
Regulatory stability
For T&D utilities operating within ERCOT, retail competition has been in place since 2002. Cost-of-service-based recovery mechanisms have been in place for several years and permit T&D utilities to implement interim rate changes up to twice per year, in some cases. Since 2017, T&D utilities have been required to file base rate proceedings every four years.
VIUs operating outside ERCOT implement new rates through traditional rate proceedings but are permitted to update rates on an interim basis between rate cases via various mechanisms.
Although rare, there have been instances when PUCT rate decisions have been litigated at the District Court level. The most recent was in 2017.
Tariff setting
The tariff structure is stable and mostly constructive from an investor standpoint.
Authorized equity returns are similar to or above industry averages, and utilities are generally able to earn authorized returns.
Remuneration for all investor-owned utilities allows for recovery of investments and operating expenses in addition to financial remuneration. This includes fuel and purchase power costs for VIUs. T&D utilities operate without commodity exposure.
The PUCT monitors utility earnings on an annual basis. When there is potential overearning by a utility, the commission may conduct a more comprehensive review.
Financial stability
Utilities can recover most costs, and Texas legislation allows for extraordinary cost recovery in most cases. However, the PUCT has generally not permitted a cash return on construction work in progress.
Regulatory independence
PUCT commissioners are appointed by the Governor of Texas and confirmed by the Texas Senate. While minority party representation is not required, Senate confirmation requires a two-thirds vote.

Key Stakeholders

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Electric Reliability Council of Texas

ERCOT is an independent system operator (ISO) and the regional transmission operator (RTO) that coordinates the flow of electricity from over 710 generation units to more than 26 million electric customers in Texas. ERCOT accounts for about 90% of the state's electric load. The remainder is coordinated by three RTOs that extend into Texas: the Western Electricity Coordinating Council (WECC) in the west, the Southwest Power Pool (SPP) in the north, and the Midcontinent Independent System Operator (MISO) in the east. ERCOT is subject to oversight by the PUCT and the Texas legislature.

Texas Electric Choice

The Texas electricity market's current form has been in place since about 2000, when legislation implemented so-called retail choice, which allowed customers within ERCOT the ability to select their generation supplier. Following this restructuring, VIUs in ERCOT were required to unbundle their operations, creating retail electric providers (REPs), unregulated power generators, and T&D utilities. Utilities that were unbundled include AEP Texas Inc., Oncor Electric Delivery Co. LLC, CenterPoint Energy Houston Electric LLC (CEHE), and Texas-New Mexico Power Co. (TNMP). Outside of ERCOT, however, the traditional vertically integrated structure remains. VIUs outside of ERCOT include Entergy Texas Inc., Southwestern Public Service Co. (SWPSC), and Southwestern Electric Power Co. (SWEPCO).

Chart 1

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Jurisdiction Under The PUCT

In addition to electric utilities, the PUCT regulates telecommunication, water, and sewer utilities in the state. Within ERCOT, this includes investor-owned T&D utilities. Outside of ERCOT, the PUCT regulates the investor-owned VIUs, and electricity transportation is coordinated under the regional-specific RTOs. The PUCT also oversees ERCOT, the registration of power generators, and the REPs.

Notably, cities in Texas maintain original jurisdiction over distribution rates within the confines of the city, where the PUCT holds appellate jurisdiction, but the PUCT presides outside city limits. In practice, however, various cities have generally ceded rate regulation authority to the PUCT.

Assessing Regulatory Advantage

The regulatory framework's influence is of critical importance when assessing regulated utilities' credit risk because it defines the environment in which a utility operates and has a significant bearing on its financial performance. Our assessment of regulatory advantage incorporates relative credit supportiveness on our view of how regulatory stability, efficiency of tariff-setting procedures, financial stability, and regulatory independence protect a utility's credit quality and its ability to recover its costs and earn a timely return. Our view of these four pillars is the foundation of a utility's regulatory support.

Regulatory Stability

When assessing regulatory stability, we review the transparency of the key components of rate setting, the predictability of the framework, and the consistency of the framework over time. The regulatory framework for utilities under the PUCT has been consistent for several years. The PUCT has generally applied consistent ratemaking across T&D utilities and VIUs. Ratemaking has followed the traditional process, with rates set through a combination of periodic base-rate filings and interim cost-recovery filings. Between these reviews, the PUCT monitors utility earnings on an annual basis and conducts investigatory reviews under situations of potential overearning. In 2018, for example, an annual earnings review determined that transmission company Wind Energy Transmission Texas LLC had earned a 12.43% ROE, and the PUCT ultimately required the company to reduce its wholesale transmission rates by $16 million to better align with its authorized level. Cases such as these drove legislation to require all utilities to file a comprehensive rate review every four years.

Chart 2

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Tariff Setting

When assessing the design of a regulatory framework, we analyze whether all operating and capital costs are fully recoverable in a timely manner, the balance of interests and concerns of all stakeholders affected, and whether incentives are achieved and contained. We view traditional rate proceedings as adequate as they pertain to a utility's ability to recover its operating and capital costs in full, including a reasonable return. However, periodic proceedings can exacerbate regulatory lag, given the delay between when the costs are spent and when rates are finally adjusted. We therefore view regulatory mechanisms that provide interim rate adjustments prior to a traditional rate review as positive for credit quality, given their ability to minimize this lag.

With respect to cost recovery, we view regulation under the PUCT as strong, primarily reflecting the various interim rate adjustment mechanisms that minimize regulatory lag. Further, we believe utility revenues are set at a level sufficient to recover ordinary operating and capital costs in full, albeit on a historical basis.

Within ERCOT, transmission cost-of-service (TCOS) mechanisms permit transmission service providers to adjust rates twice annually to recover costs associated with new transmission investment. VIUs operating outside ERCOT are also permitted to recover costs associated with new transmission investments, albeit once annually, through a transmission cost recovery factor (TCRF) mechanism. On the distribution side, distribution service providers across Texas are permitted to recover costs related to new distribution investment via a Distribution Cost Recovery Factor (DCRF) once per year. Further, distribution service providers across Texas are permitted to recover fees paid to third-party transmission service providers via a TCRF.

Financial Stability

When assessing the financial stability of a regulatory framework, we look at the timeliness of cost recovery and cash-flow volatility, how much flexibility there is in the framework to allow the recovery of unexpected costs, the attractiveness of the framework to long-term capital, and capital support during periods of heavy investments. We view the ability to recover costs associated with new transmission investment between base rate cases favorably. With respect to generation cost recovery, legislation enacted in 2019 permits the PUCT to adopt a mechanism that allows VIUs to implement a rider for new investments in regulated generation. However, the rider does not allow utilities to include construction work in progress in rate base for a cash return; usage of the rider commences only as of the date the plant begins commercial operation. With respect to fuel and purchased power costs, VIUs recover these through ordinary mechanisms, with fuel reconciliations occurring at least every three years but no more than every 12 months.

Chart 3

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Given the history of storm-related activity in Texas, particularly for service territories along the Gulf Coast, the state's regulatory framework aptly considers the treatment of storm-related costs. Securitization has been utilized in numerous cases to fund utility restoration costs, such as in 2006, when Entergy Texas was authorized to issue over $300 million in bonds following Hurricane Rita. This approach was also used to recover costs associated with stranded generation assets following the electric restructuring in the early 2000s and the unbundling of VIUs.

Regulatory Independence And Insulation

When assessing regulatory independence and insulation, we look at the market framework, how the law preserves and separates the regulator's powers, and any risks of political intervention. In many jurisdictions, the role of the regulator is to set and regulate rates and service standards with due regard to all stakeholders, including customers, utility operators, investors, and other constituents. How politics could influence regulation helps us evaluate a regulatory environment around political and economic risks. PUCT commissioners are appointed by the Texas governor and require a two-thirds Senate vote confirmation; although minority party representation is not required, we believe politicization of the ratemaking process has been limited to-date. Cash flows generated through the regulatory framework remain stable and consistent with historical levels. Following Winter Storm Uri, PUCT commissioners resigned after various state politicians began asking for resignations. We are monitoring for any impact to credit quality from the PUCT commissioner turnover, particularly around rate recovery of costs including those related to Winter Storm Uri.

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:William Hernandez, Farmers Branch + 1 (214) 765-5877;
william.hernandez@spglobal.com
Secondary Contact:Daria Babitsch, New York 917-574-4573;
daria.babitsch1@spglobal.com

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