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S&P Sees Sustained High Gas Prices a Threat to LDC Credit Ratings

S&P Sees Sustained High Gas Prices a Threat to LDC Credit Ratings

This third winter of high natural gas prices could strain the finances of local distribution companies, especially if regulators fail to allow the timely pass-through of gas costs, according to a Standard and Poor's report.

"A prolonged period of high natural gas prices without timely reimbursement of deferred gas cost balances can rapidly deplete an LDC's liquidity," the S&P report revealed last week. "Also, in a high-price environment, those firms that use hedging or storage to mitigate risk to end-users need greater short-term liquidity to pay for the commodity." Thus "how quickly the purchased gas adjustment is 'trued up' can have a bearing on an LDCs credit quality. Slow recovery could impinge on the firm's liquidity as short-term funds are consumed to finance high-cost gas purchases."

"Although most LDCs are poised to survive the third consecutive winter of higher commodity prices, continued regulatory support is paramount to the LDCs' credit quality," said S&P analyst Brian Janiak.

In order to maintain credit quality, ratepayers must bear the responsibility for commodity costs. "Automatic pass-through mechanisms linked to gas price indices provide the strongest level of support," the S&P Report said. "Lesser clauses, including mechanisms that require after-the-fact approval by regulators, pre-set gas cost adjustment levels and pre-approved hedging policies introduce the potential for disallowance" if regulators challenge the prudency of the purchasing strategy.

Other factors involved in a risk evaluation of LDCs include supply sources, storage position, hedging and rating actions. For instance, accessing supplies from multiple sellers and pipelines from more than one basin helps protect against disruptions. It also gives the LDC a competitive purchasing position.

Besides providing peak supply security, owning storage gives LDCs without straight pass-through, opportunities to arbitrage seasonal pricing fluctuations. "Some LDCs can meet more than 50% to 60% of peak demand with company-owned storage. Such storage has lowered the company's average commodity costs and allowed it to meet peak demand without having to buy transportation."

"Prudent, consistent hedging programs that have been pre-approved by regulators are viewed as an attribute of credit strength." For instance, Piedmont Natural Gas has been pre-approved by its state regulatory commission to enter into call options and collars, Janiak said. At the end of the heating season if the company incurs excess costs in the hedging program, the regulatory commission may allow those costs to be rolled into the gas costs.

The report notes there have been several adverse rating actions for LDCs over the last 24-28 months, including eight outlook revisions to negative, three CreditWatch placements with negative implications, as well as four rating downgrades. These actions were for a combination of reasons, one of which is weak regulatory mechanisms and support. Other ratings negatives stemmed from sustained high leverage and weaker-than-expected credit protection measures, increased exposure to or investment in non-regulated businesses, or increased debt-financed acquisitions or capital investments.

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