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S&P: Utilities More Credit 'Balance' in '05, but Downgrades Dominate

February 6, 2006
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As a whole, U.S. utilities (energy and water) last year struck more of a balance in their collective credit ratings, but credit rating downgrades dominated again, according to the annual survey for 2005 by Standard & Poor's Ratings Services. S&P recorded 46 downgrades in 2005, compared to 36 upgrades; in the fourth quarter the ratio was 19 downgrades to 9 upgrades.

A big turn upward in utility credit ratings over the next few years is unlikely, S&P concluded. But it also noted that the outlook for regulated utilities remains "reasonably stable" as much of the industry has been what S&P called "reemphasizing its core competencies." Reliance on external capital stayed "relatively steady" last year ($51.8 billion, compared with $53.9 billion in 2004), S&P said.

According to the rating agency, the credit downgrades last year were attributable to a wide variety of factors for electric, natural, pipeline and water utilities. Among them are deterioration in bondholder protection, unresponsive state regulatory decisions, a heightened adversarial atmosphere, and more aggressive growth strategies by the utilities.

In contrast, "upgrades were traced to reduced exposure to riskier unregulated activities, healthier balance sheets, increasing free cash flow and other financial positives that have raised "expectations of sustained profitability," S&P said in its report, "Pace of U. S. Utility Rating Actions Picked Up in 2005," overseen by S&P's primary credit analyst for the survey, Barbara A. Eiseman.

Overall, the utilities were predominantly a triple-B rated industry ("BBB") by S&P, with 54% of the ratings at that level, contrasted by 2% at the highest double-A level ("AA"), or the lowest with 1% ("CCC" and lower).

"Many companies face various business and financial pressures, which resulted in their ratings going on 'CreditWatch-with-negative-implications' in 2005," the S&P report said. "CreditWatch listings and rating outlooks are good indicators of prospective rating actions, and given the numerous new and existing negative CreditWatch listings and negative credit outlooks, any upturn in overall ratings quality is unlikely over the intermediate term."

S&P said the percentage of stable utility rating outlooks stood at 61% the end of 2005, "materially higher than the 54% level posted at the end of 2004." Negative outlooks also declined markedly to 14% at the end of last year, compared 33% at the end of the previous year. However negative CreditWatch listings rose to nearly 11% from the 3% level the year earlier.

For both the downgrades and the upgrades in credit last year, S&P highlighted several utilities in each category, with Pinnacle West Capital Corp.'s Arizona Public Service Co. (APS) being one of the most recent downgrade examples due to what S&P said were "increased regulatory and operating risk" that still had not been fully addressed by state regulators in their decision late last month. APS is still seeking emergency rate relief to take care of mounting deferred fuel and purchased-power costs.

"Any adverse regulatory action or continued delays in resolving the pending surcharge request could result in negative rating action," S&P said in concluding its summary of the APS example.

On the up-side of the equation, S&P's report cited the two big California utilities -- Southern California Edison Co. and Pacific Gas and Electric Co. -- as examples of several western-based utilities whose credit has shot upward on the heels of favorable regulatory developments. Texas-New Mexico Power Co. (TNP) since its acquisition by PNM Resources and Portland, OR-based Northwest Natural Gas Co. were also cited in the improved rating grouping, although there was an asterik attached to TNP, whose outlook recently slid back to "negative," S&P said, because of "weakening financial performance resulting from decreased availability at Palo Verde nuclear generating station in Arizona."

In the merchant generation sector, S&P's report also found credit ratings "relatively stable," with some major exceptions -- Calpine Corp. (lowered to junk "D" status) being the major one. The rating agency speculated that Calpine's ongoing Chapter 11 bankruptcy proceeding is likely to be "protracted and highly contentious."

"Excess capacity in certain energy markets will continue to present a challenging operating environment for merchant generators despite financial restructurings," S&P concluded. "The creditworthiness of many purely merchant power companies is constrained by fluctuating cash flow from operations despite some improvement in power markets in certain regions."

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