The goals of deregulation within the U.S. power markets “remain frustratingly elusive,” with more states retreating from the process and regulators pursuing investigations into trading and accounting practices, said Standard & Poor’s in a report released this month. Noting that restructuring was supposed to induce more efficiencies and reduced prices, S&P said widening credit spreads and equity prices have instead sent investors “fleeing” from the sector — and the trend may continue for some time.
The report, “Partial Restructuring of US Power Markets: At What Cost to Credit?,” said that credit risks could “intensify in the face of continuing regulatory and political uncertainty. Investors may find that generation assets, particularly new construction, are at risk of becoming partially stranded investments if they cannot access their intended markets or simply cannot transact” as they were intended.
“Partial restructuring has created dysfunctional wholesale electricity markets,” said S&P analysts. “This, in part, is due to a transmission system that largely is not designed to operate in competitive markets. Many markets allocate transmission usage using non-market-based means while generation tries to operate competitively. In such a market, the premise of investments may prove wrong and investors may find themselves at risk of a credit surprise. Worse still, political and regulatory uncertainty may be thwarting much needed new investment in infrastructure, a situation that could be exacerbating credit risk for parts of the industry.”
However, S&P expects restructuring to “forge ahead,” because “it is easier to let the cat out of the bag than to put it back in.” Several major markets, including New England, New York, Pennsylvania-New Jersey-Maryland (PJM) and Texas, “are well into restructuring and are not turning back. Moreover, the industry’s turmoil has neither completely consumed the FERC nor paralyzed it.”
As the Federal Energy Regulatory Commission moves ahead with electricity reform, S&P said it was cautioning investors that deregulation would not follow the same path of other restructured industries in the United States or overseas. “Electricity is a unique commodity, if indeed it can be called a commodity, and because of its differences, credit surprises could be in the making.” It said that the rules that apply in other markets such as traded financial securities, or oil and gas, essentially “break down” in electricity markets, making an analysis of investment and credit “a thorny task.”
According to S&P, among the issues setting electricity apart are the following:
“Such characteristics,” said S&P, “particularly the volatility, potentially turn what might be a small credit concern in a functional market into a much bigger credit problem in a partially deregulated environment. For example, a generator with an all-requirements contract that cannot access transmission during a congestion period may find itself paying a fortune in replacement power to satisfy contractual obligations to its seller.”
However, problems in California coupled with the Enron Corp. investigation have “strengthened FERC’s restructuring resolve.” S&P noted that standardized wholesale market design will be FERC’s next step, but “gaining consensus among industry participants and stakeholders will be a major challenge.”
If and when FERC implements a new market design — which S&P analysts believe could be years — that includes “economically valued transmission,” it said it “expects that some stakeholders may face a changed credit environment.” If they still own generation, some utilities will see new credit pressures, said S&P. Although credit downgrades “are not inevitable…the potential will force hard decisions about capital structure and operations.” Also, generators will geographically attractive locations could have lower revenues or be forced out of business if they are not competitive, while other generators would see better economics if they are allowed access to larger markets and better pricing.
Reacting to its recent downgrade decisions, S&P said the “interim state of U.S. restructuring has left a cloud of uncertainty over investors and lenders. That in and of itself raises credit risk.” S&P said it expects FERC and many states “to press ahead with restructuring, but expect a slow timeframe. In particular for the FERC, restructuring will be a major initiative after the current turmoil subsides. In the meantime, however, credit risk will not likely abate.”
More information on the S&P report may be found at www.standardandpoors.com/ratingsdirect.
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