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Fitch: Low Natural Gas Prices Spells Trouble for Generators

Fitch Ratings in a report last week said continued weakness in natural gas prices may spell trouble for many U.S. independent electricity generators.

If gas prices stay at $3/MMBtu or lower, independent generators (gencos) could run into problems by 2014, which is largely unhedged for them currently, the Fitch report said. Impacts will vary between investment-grade and noninvestment-grade gencos, the ratings agency said.

"There is clearly downward pressure on credit metrics for both investment- and noninvestment-grade gencos as hedges roll off beyond 2013 and natural gas prices do not improve," said the Fitch report "Gauging Gencos' Vulnerability to Low Natural Gas Prices."

The forward natural gas price curve, which has fallen sharply since last year, remains in a range of $2.50-4/MMBtu, compressing margins for the gencos. The extent of the impact varies on each genco based on a host of factors, including their fuel mix, hedges, geographical locations, the extent they have retail operations, and the proportion of capacity revenues in the overall revenue mix, Fitch said.

Hedging is a mitigation factor, and most of the gencos are heavily hedged for this year, and most are above current market price levels. In 2014, however, the adverse exposure grows, the report said.

"Fitch found that most of the gencos have hedged more than two-thirds of their expected generation for 2012; however, their hedge percentages are quite small for 2014. As a result, gross margins across gencos exhibit a high sensitivity to changes in gas prices in 2014 and beyond."

Looking ahead, Fitch analyses have shown that the credit for gencos could deteriorate even with gas prices in the $3-4 range. Thus, gas prices and the long-term credit rating of the generators can be closely tied. "[Our] analysis did illustrate that credit metrics for most gencos are expected to weaken as existing above-market hedges roll off and if the commodity [price] environment does not improve. The stand-alone generators are already rated deep into the noninvestment-grade spectrum."

There are ways that some of the gencos will be able to ward off adverse rating actions from Fitch through strong parent linkages, headroom in credit metrics, strong retail operations and the "likely benefit from high energy/capacity prices as coal plants are controlled and/or retired in their regions due to more stringent environmental regulations." If these factors are inadequate for some gencos, Fitch will expect them to "realign their capital structure" to mitigate a downward bias in the sector's credit ratings.

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