Citing supportive local governance, Moody's says public power credit outlook is stable
Originally published June 17, 2013
The outlook on U.S. public power utilities continues to be stable as public utility boards generally remain supportive of raising rates or cutting costs as necessary to maintain current financial performance, Moody's Investors Service said in a new report. "The unregulated cost recovery process will remain intact over the next 12 to 18 months, which should allow for supportive and timely rate-setting and stable financial metrics," said Moody's Senior Vice President Dan Aschenbach, who wrote "U.S. Public Power Electric Utilities: Limited Threats From Local Governance Underscore Credit Stability."
The primary factor in the several rating downgrades in the sector in 2012 "was a reluctance among some governing boards to raise rates or cut costs sufficiently to maintain sound financial metric thresholds for a given rating category," the report said.
Moody's expects the multi-year improvement in the financial metrics of public power utilities to continue after a notable decline in 2009 due to the recession, with low fuel and energy prices contributing to their stable performance. Some smaller and medium-sized utilities may see some strain in their financial measures, however, as they phase in the fixed costs of new power projects that are coming on line, Moody's said.
The public power electric utility business model remains unchanged despite fiscal pressures on some local governments and these fiscal pressures should not affect most utilities, Moody's said. "We see no legislative or regulatory change to how public power utilities operate," Aschenbach said. There have been only "some limited privatization proposals and increased intervention unique to several utilities."
There should be limited federal action (exclusive of environmental regulation) in the next year on other policies that could affect the role of public power utilities, Moody's said. Recent proposals to sell the Tennessee Valley Authority and a plan to alter the role of the federal power marketing administrations "could have significant impact but both proposals do not appear to have broad bipartisan support," the report said.
Federal environmental regulations are the chief source of possible negative pressure, Moody's said. Climate change policy is one of the most significant uncertainties regarding the outlook of the electric utility sector because of the estimated significant cost, the report said. Extreme weather patterns "could move federal carbon policy forward and lead to more restrictive air and water regulations, creating a less favorable transition timetable for electric utilities to comply with regulations."
For coal-fired plants, it is certain "that the myriad of existing federal Clean Air [Act] and Clean Water [Act] regulations will continue to be implemented and that compliance costs will represent an increased share of new capital investment," Moody's said. "Whether the regulations will remain on the announced schedules for compliance remain uncertain." Given the transition time, the credit impacts on public power utilities should be manageable, the report said, although compliance with mercury limits may still prove problematic because of the cost of compliance.
Other potential risks include the challenges that renewable energy sources generally present and threats to power source diversity as more capacity adjusts to natural gas, Moody's said. "With just one new coal generation unit being built, limited new nuclear units being constructed, and a pause in new renewable energy projects, the [electric industry’s] herd mentality is moving towards natural gas." Maintenance of a diverse power resource mix has been an important credit strength for public power utilities, Moody's said.
"Most regions in the U.S. do not have the transmission grid resiliency nor operating procedures in place to mitigate the issues of intermittent generation when wind or solar generation becomes a larger portion of a region's power mix," said Aschenbach. While California was successful at reaching its 20 percent renewable energy standard by 2012, "it now runs the risk of significant market and financial disruption as the state lacks the adequate transmission to deal with the intermittency issue and is also experiencing the loss of variable natural gas generation due to new more restrictive water quality regulations," the report said.
The energy and capacity markets run by regional transmission organizations pose new risks, Moody's said. "For example, new generation capacity requires long-term contracts to secure financing. This fits the public power business model well. However, capacity markets offer short term contractual revenues that have more volatile auction-based pricing schemes and hold the potential of under-recovery of fixed costs," the report said. "This difference has the potential to be a credit risk subjecting public power electric utilities to more market price risk exposure."
Despite threats to the tax-exemption on municipal bonds, sound access to capital to fund new generation and transmission remains in place, Moody's said. Congress's search for federal deficit solutions, along with a sequestration cut of 8.7 percent on the Build America Bonds interest subsidy, has fueled the debate about tax exemption of municipal bonds, the report said. The recent experience with Build America Bonds suggests that, at least for the public power sector, "taxable investors saw the fundamental strengths in the sector which was reflected in the favorable final pricing on revenue bonds."
Record low taxable and tax-exempt interest rates during next year should keep conditions favorable for new investment, Moody's said. However, public power capital investment for new generation "will be limited to the new nuclear generation in the Southeast U.S.; gas-fired generation, renewable energy projects and for environmental compliance."
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