Unexpected pressure on three key cost components of US electric
utilities - natural gas prices, interest rates, and operating and
maintenance (O&M) - could have a meaningful impact on ratings, Fitch
We looked at what would take place should upward pressure on natural gas
prices, interest rates and O&M became stronger than expected, assessing
the impact on retail rates assuming full recovery of such costs in
rates, the impact of higher customer bills on the US regulatory compact
and credit ratings, and if this scenario would likely lead to future
credit rating downgrades. The results of this review are available in a
new report: "U.S. Utilities: Unexpected Cost Pressures Could Challenge
Ratings," available at the link above and on www.fitchratings.com.
Fitch considered the impact of an increase of $1, $2 and $3 per million
British thermal units (mmbtu) in the price of natural gas for a sample
of 25 large electric utilities' retail rates assuming full cost
recovery. Additionally, we considered the impact of a rise in interest
rates and O&M expense on retail rates.
Results imply a pro forma revenue requirement of 4.7%-10.3% for the
electric utilities in the sample to fully recover the combined stress
increases in natural gas, interest rate, and O&M costs across the three
scenarios. Natural gas represents 2.4%-7.5% of the increased revenue
requirement, reflecting its growing use in power generation. Interest
rate increases push cost recovery in retail customer rates 1.3%-1.5%
higher, while O&M drives rates higher by 1.0%-1.3%.
The 25 companies' median rating is currently on the cusp of 'BBB+/A-',
with coverage and leverage metrics that provide a relatively modest
cushion. In a stress scenario characterized by sustained, meaningfully
higher natural gas and interest rates, Fitch believes ratings would
likely migrate to lower levels driven by qualitative (higher risk) as
well as quantitative (weaker credit metrics) factors and emerging
secular challenges considered in Fitch's current sector outlook.
Contrary to the stress-case scenarios considered in this report, Fitch's
sector outlook is stable, reflecting expectations that include tepid
recoveries in natural gas prices and in interest rates from a low base.
Fitch's base case for Henry Hub natural gas price increases to
$3.75/mmbtu in 2018. Similarly, projected interest rate gains are likely
to be muted. This moderate cost trajectory is generally consistent with
the Fitch's current ratings and stable sector outlook.
Fitch does not anticipate a sharp rebound from today's low natural gas
and power price levels or interest rates. However, a sharp, sustained
rise in these key cost inputs cannot be ruled out. This would exacerbate
structural and policy cost pressures related to environmental
regulations and infrastructure replacement and upgrade. In that
scenario, rising electricity rates could lead to political tensions,
more contentious rate proceedings and pressure on credit metrics.
Additional information is available on www.fitchratings.com.
The above article originally appeared as a post on the Fitch Wire credit
market commentary page. The original article, which may include
hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com.
All opinions expressed are those of Fitch Ratings.
U.S. Utilities: Unexpected Cost Pressures Could Challenge Ratings
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