Hoisted somewhat on the petard of its own success and a shrinking merchant power market nationally, San Diego, CA-based Sempra Energy and its two principal utility subsidiaries had their credit ratings downgraded Wednesday by Standard & Poor’s, reflecting Sempra’s increased earnings from the nonutility businesses, particularly energy trading.

In making its 2001 earnings report earlier in the year, Sempra’s CEO noted the company had exceeded its goal of having at least one-third of its overall earnings come from the nonutility businesses, so he announced a new strategic goal of more than half of the earnings coming from those businesses by 2004. With the added risk and volatility of those businesses, S&P lowered Sempra’s corporate credit rating to single-A-minus from single-A; and the utilities, San Diego Gas and Electric Co. and Southern California Gas Co., to single-A-plus from double-A-minus.

“The downgrades reflect the substantial increase in contribution to earnings and cash flows from unregulated ventures such as energy trading, merchant generation and international operations in Mexico and South America,” S&P said in its news announcement, noting that Sempra’s nonutility businesses accounted for just 1% of the earnings two years ago, and now are targeted to jump to half in another two years.

“Sempra’s consolidated cash flow interest and debt coverage levels (3.8 times and 22.2%, respectively at year-end 2001) no longer support the increased business risk of the enterprise at the level of the former ratings,” the rating agency said.

Overall, S&P said Sempra’s outlook remains “stable,” given the predictable cash flow from the two large utilities and its large amount of merchant power that is already committed under a long-term contract with the state.

The rating agency was bullish on the two major Southern California-based utilities, noting that SDG&E was “relatively unscathed” by California’s electricity crisis of last year that has left the state’s other two major private-sector utilities struggling to regain investment grade ratings. It also said SoCalGas likely will continue “to generate solid earnings and cash flows” as the nation’s largest natural gas distribution utility.

Sempra Energy Trading, however, gives S&P reason to lower the rating because its performance “will fluctuate the most” among the Sempra companies due to the inherent volatility of the trading business. As far as the trading sector goes, however, S&P also acknowledged that Sempra has a relatively modest risk profile, keeping a short-term horizon on 90% of its trades and buying Enron Corp.’s metals brokerage and warehousing operation, which the rating agency views as “indicative of management’s modest risk appetite and its broad trading strategy.”

On the merchant power side, Sempra Energy Resources has hedged two-thirds of the capacity of its existing and near-term output under long-term contract with California’s power-buying agency, the Department of Water Resources (DWR). By the spring of 2004, Sempra will invest $1.4 billion in four new gas-fired combined-cycle plants, all of whose output is largely tied to the DWR contract.

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