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 October 21, 2015 - 1:05 PM EDT
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Fitch: Unexpected Cost Pressures Would Challenge US Utility Ratings

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 Ratings says.

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

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=872250

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Fitch Ratings
Philip W. Smyth, CFA, +1-212-908-0531
Senior Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Kellie Geressy-Nilsen, +1-212-908-9123
Senior Director
Fitch Wire
or
Media Relations
Alyssa Castelli, New York, +1-212-908-0540
alyssa.castelli@fitchratings.com


Source: Business Wire (October 21, 2015 - 1:05 PM EDT)

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