Citing the prospect of continuing high and volatile commodity prices, Fitch Ratings’ 2007 outlook for the U.S. power and gas industries is generally stable, particularly in the competitive part of the industry. Not so fortunate are the regulated gas and electric sectors, which face “a challenging environment.” And no company should become complacent. Risks, demand and interest rates could change over the longer term.

“Natural gas and wholesale power prices, while below recent highs, have plateaued at still elevated levels,” and with continuing volatility, Fitch notes. This bodes well for the ability of businesses in competitive markets for electric generation, gas gathering, processing and storage to raise capital. Pipeline companies are relatively insensitive to the level of commodity prices.

Conversely, higher prices combined with the rising costs of other elements could be a negative for the regulated gas and electric utility sectors, where tariff increases may not cover the costs, and cash flows could suffer. Fitch sees some utilities such as public power utilities, gas distributors and most traditionally regulated integrated investor-owned electric utilities as being better positioned to recover rising costs. Local distribution companies generally already have absorbed the sharp increase in natural gas prices during 2005-06 and are recovering costs from their customers.

Some investor-owned electric utilities, however, face regulatory and political backlash that could limit their ability to recover costs, Fitch says in rating these entities “mildly negative.” The agency particularly notes investor-owned utilities in states that restructured five to six years ago or that have multi-year rate freezes.

Fitch says the credit outlook for electric utilities could be affected by rising capital expenditure (capex) requirements to replace aging infrastructure, add new power and transmission facilities, and meet environmental mandates. “While capex is not intrinsically a negative credit factor for regulated utilities, it will add to cost pressures.”

Conditions are generally good right now for the oil and gas sector, but all good things come to an end. In the interim and longer term, Fitch warns against getting overextended “without considering the potential for a shift in the capital market environment or downturn in valuations…Easy and liberal financing has accelerated merger and acquisition (M&A) activity, and it would be unsurprising to witness some fall-out from the lofty prices being paid for power and gas assets and/or companies.”

Particularly companies with large, longer-term construction commitments could see conditions — and interest rates — change. “As the capex cycle moves into a later stage, companies with large construction commitments are more vulnerable to completion delays, cost overruns, or increases in market interest rates.”

Not to be forgotten also is the possibility that continuing higher prices, and the demand management response, will eventually lead to reduced consumption, at the same time that costly new facilities come on-line.

Fitch’s full 2007 outlook report can be accessed at www.fitchratings.com by clicking on the ‘2007 Outlooks’ icon. The report includes Fitch’s current ratings and Outlooks for over 370 entities in the sector. Coinciding with the release of the 2007 Outlook, Fitch has also published a special report analyzing 23 issuers in the North American oil and gas industry. The companies are Ameren, AEP, Constellation, Dominion, Duke, Dynegy, Edison International, Energy Transfer Partners, Entergy, Enterprise Products, Exelon, FirstEnergy, Kinder Morgan, MidAmerican Energy, Mirant, NRG, PEPCO, Progress Energy, Sempra Energy, Sierra Pacific, TXU, Wisconsin Energy and The Williams Cos.

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