S&P sees more credit risk in U.S. power names from deregulation

By Ronda Fears

Nashville, Tenn., July 15 - Deregulation of the U.S. electricity industry has created credit risk that could intensify further in the face of uncertainty, not the least of which centers around federal probes into power trading accounting practices that also have stalled the process, Standard & Poor's said in a report Monday.

"The U.S. transition to competitive wholesale power markets has stalled. Indeed, many states are retreating from restructuring [deregulation of U.S. power markets] as the FERC, the SEC and politicians are vigorously pursuing their investigations into trading and accounting practices," said S&P analyst Peter Rigby in the report.

"Widening credit spreads and equity prices that have fallen to multiyear lows have sent investors fleeing from the sector. And credit risk could still intensify in the face of continuing regulatory and political uncertainty."

Also, S&P is refining its methodology for rating energy trading and marketing companies.

In a separate report Monday, S&P said the new methodology will have implications for both issuers and investors.

"For traders, some may require higher levels of equity capital and liquidity to maintain existing credit ratings," said S&P analysts in the report, noting S&P will require more information from companies.

"More so now than ever before, energy trading and marketing is a highly confidence-sensitive operation - confidence in credit, management, and disclosure, among other areas, is a critical requirement for counterparties, creditors, and investors."

The need to post more than $500 million in collateral following a credit downgrade below investment grade is more the norm than an exception with the larger players, the analysts said.

Deregulation, or restructuring, of U.S. power markets was supposed to induce greater efficiencies and reduce prices to consumers as well as foster greater innovation and investor confidence for much needed new infrastructure development, Rigby said.

Yet the U.S. transition to competitive wholesale power markets has been hampered by the trading scandals, he said, leaving the goals of restructuring frustratingly elusive.

Credit risk could become greater, Rigby said, as electric generation assets, particularly new construction, are at risk of becoming partially stranded investments if they cannot access intended markets or conduct business as intended.

Also, he noted, some older generation units could see the good times end if the restructuring transition suddenly advances and a functioning market strips their competitive insulation.

"Partial restructuring has created dysfunctional wholesale electricity markets," Rigby said.

"This, in part, is due to a transmission system that largely is not designed to operate in competitive markets."

Thus, he said, the premise of investments may prove wrong and electric generators may find themselves at risk of a credit surprise.

"Worse still, political and regulatory uncertainty may be thwarting much needed new investment in infrastructure, a situation that could be exacerbating credit risk for parts of the industry," Rigby said.

Nonetheless, the analyst said to expect restructuring to forge ahead.

"As some unknown cowboy philosopher said, 'It is easier to let the cat out of the bag than to put it back in,'" Rigby said.

Major markets, mainly New England, New York, Pennsylvania-New Jersey-Maryland and Texas, are well into restructuring and are not turning back, he pointed out.

"Moreover, the industry's turmoil has neither completely consumed the FERC nor paralyzed it," Rigby said.

"The FERC is moving forward with restructuring."

According to FERC Commissioner Nora Brownell, who spoke at a recent S&P co-sponsored conference in New York, "The cost of doing nothing is greater than the cost of doing something."

He said Brownell also stated that the vulnerability of the entire market terrifies the FERC and that the reality is that the current electricity infrastructure will not support economic growth in the U.S.

As the FERC presses ahead with electricity reform, he said S&P is cautioning investors that deregulation will not follow the paths of other restructured industries in the U.S. or abroad.

"Electricity is a unique commodity, if indeed it can be called a commodity, and because of its differences, credit surprises could be in the making," Rigby said.

"At a minimum, restructuring is a lengthy work in progress that could take many turns along the way."

The U.K. electricity regulator, for instance, has made numerous changes since deregulation began in 1991 to an industry structure that has affected, and continues to affect, the credit of most participants.

But the effects were not uniform.

S&P expects that U.S. restructuring also will affect credit differently for industry participants, as it already has.

"Much of the effects will rest with how participants themselves choose to capitalize their firms, as well as in what parts of the industry they chose to enter and in what markets they elect to compete," Rigby said.

"Nonetheless, the interim state of U.S. restructuring has left a cloud of uncertainty over investors and lenders. That in and of itself raises credit risk."

The absence of a standardized wholesale market design, which includes an efficiently operating transmission system, raises credit concerns, he said.

"Some buyers and sellers of power cannot enter into some transactions when power is most expensive because transmission is allocated using non-market methods," Rigby said.

"For some, that means cash flow may be lower than anticipated. That's a credit risk."

Lack of a standardized wholesale market design is masking price signals that either lead to infrastructure investments in the wrong locations, the wrong type or no investments. That's a credit problem, he said.

"If the FERC is successful in promoting a standardized market design, look for winners and losers during the transition," Rigby said.

"But many more participants will have to confront competition and that has historically pressured credit in this industry. Look for the FERC and many states to press ahead with restructuring, but expect a slow timeframe. In the meantime, however, credit risk will not likely abate."

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.