A new report from Moody’s Investors Service says that public power and electric generation and transmission cooperative utilities face rising risks from the country’s carbon transition, but also notes that public power utilities have unique attributes as compared with investor-owned utilities and cooperatives including electric rates that are materially lower than both IOUs and G&T coops.
Utilities with lower rates “will have greater flexibility in resource planning and in pacing their carbon transition,” Moody’s said in the May 15 report, “Prudent self-regulation is key to managing carbon transition risks.”
The report notes that public power and G&T cooperative utilities account for only about 28% of electricity sales in the US, “but face the same growing imperative to reduce emissions as the dominant investor-owned utility (IOU) sector, driven by a combination of state and local level policies as well as customer preferences.”
But the rating agency also said that there are important differences in business model, governance and rate-setting that mean public power and G&T coops “face somewhat lower carbon transition risks than IOUs but also lack some of the benefits and opportunities that IOUs enjoy.”
Moody’s said that the transition to a low-carbon electric grid creates risks for all utilities, primarily centering on the potential for stranded assets.
“Utilities may be required to shut down generation assets with high fixed costs, especially coal plants, before the end of their useful life. Continuing to recover those capital costs while obtaining replacement power from another source could create affordability concerns if rate increases required are significant and hence politically sensitive,” the report said.
The rating agency said that on average, public power and G&T coops have a higher carbon intensity in their generation fleet than their IOU peers.
According to statistics compiled by the American Public Power Association covering 2016, the coal generating capacity ownership of cooperatives, IOUs and publicly-owned utilities breaks out as follows: Cooperatives (39.5 percent), IOUs (33.3 percent) and publicly-owned (27.2 percent).
Public power and G&T coops own the majority of the generation assets they rely on to serve customers and, because they generally serve smaller cities and rural areas, tend to have a greater share of coal in their generation mix, the report said.
There exists a wide variation among these utilities, and many have low-carbon portfolios.
To illustrate this point, Moody’s notes that public power utilities such as Los Angeles Department of Water and Power, Sacramento Municipal Utility District and others located in California are required to meet the state’s renewable energy standard of 33% by 2020 and 50% by 2030. “Most of these utilities are either already coal-free or plan to be so by 2025 (LADWP).”
Meanwhile, other public power entities have abundant access to hydro power in the Northwest, such as Bonneville Power Administration, Seattle City Light and Chelan, Douglas and Grant county public utility districts.
Other factors influence assessment of portfolio risk
Moody’s pointed out that other considerations, besides the share of coal, influence its assessment of portfolio risk for utilities.
For example, the share of coal generation in a portfolio provides “only a static, backward-looking picture. How a utility's management plans to transition the supply mix in the future will be an important differentiating factor between utilities”;
Also, some utilities may benefit from the availability of high-quality renewable resources in their service territory.
Moody’s cites American Public Power Association report
Moreover, the report said that many public power entities have electric rates that are materially lower than both IOUs and G&T coops.
“According to the American Public Power Association, public power utility rates in 2016 were on average 14% lower than IOUs for residential customers and 6% lower for commercial customers,” Moody’s said. “While any utility would seek to avoid or minimize rate increases, utilities with lower rates will have greater flexibility in resource planning and in pacing their carbon transition.”
Paris climate accord exit
Meanwhile, the report noted that the U.S. has declared its intention to withdraw from the Paris climate agreement.
Moody’s said that U.S. withdrawal will have an impact on the sector as some states will choose not to move ahead with carbon reduction policies. “But the impact will be limited because many states and cities have committed to achieving their Paris goals. Further, many utilities have consciously transitioned towards cleaner generation, even in states politically opposed to carbon regulations, because of low natural-gas prices and the declining cost of renewables.”
The rating agency said that in the absence of state policies, public power and G&T coops have “significant flexibility in setting the magnitude, timing and pace of their carbon transition pathways, unlike IOUs.”
It said that utilities that engage early and comprehensively with their stakeholders will be better positioned to manage the transition. “However, carbon policies alone do not dictate resource decisions. The ability to maintain a reliable grid and low prices are equal, if not more significant, considerations in determining what emission reductions are feasible in a given period.”
Self-regulation sets public power/cooperatives apart from IOUs
The report also said that the ability of public power utilities and G&T coops to set their own rates – self-regulation -- is the most important differentiating factor between them and IOUs.
“Regulatory actions have an overwhelming impact on the financial performance of IOUs. Not only will regulators direct the carbon policies that utilities will implement; they also set the price utilities can charge customers.”
In contrast, Moody’s said that public power and nearly all G&T coops are not subject to rate regulation. Their revenue is “not subject to price controls under the jurisdiction of any state public service commission, a material risk mitigant from a carbon perspective.”
In order for self-regulation to be a way in which to mitigate risk from a carbon perspective, Moody’s said “it is critical that management be willing to raise rates as required to maintain the utility's credit profile.”
It said that “political risk, lack of regulatory support (when applicable) or lack of stable direction at the board level can result in an unwillingness or inability to establish sufficient rates to maintain sound financial metrics, nullifying the benefits of self-regulation. An assessment of the customer base and the service area's economic strength provides an indication of the flexibility that the utility may have in raising rates if necessary during carbon transition.”
Disruptive technologies
The rating agency also said that disruptive technologies are key to a carbon transition, and offer risks and benefits, but limited financial upside.
The report said that there is significant investment potential for utilities in renewables and the smart grid, but because public power and G&T coops are not-for-profit entities, they have no upside cash flow benefits from these investments, in contrast to IOUs. “Public power and G&T coops will nevertheless pursue these technologies because they are critical to making the carbon transition possible and in achieving these goals on a cost-efficient basis.”
Moody’s said that rate design has cropped up as a key focus to ensure fixed-cost recovery in the face of the risks posed by new technologies.
