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Utility Sector Downgrades Increased Sharply Last Year: S&P Report

image credit: S&P Global ratings
Rakesh  Sharma's picture
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I am a New York-based freelance journalist interested in energy markets. I write about energy policy, trading markets, and energy management topics. You can see more of my writing...

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For the most part, electric utilities have done a good job of handling the economic turbulence resulting from the pandemic. They issued bonds, ramped up their operations to handle increased sales to residential customers, and committed to climate and diversity goals in the midst of a dramatic reshaping of corporate America.

But the sector still ended up with the maximum number of credit ratings downgrades to its companies since 2010. In a new report, S&P Global Ratings stated that the percentage of regulated utilities with a negative outlook doubled to 36% of the overall number in 2020 from 18% in 2019. In the past years, electric utilities with credit rating upgrades outpaced those with downgrades.

Credit ratings for a company are issued after consideration of several factors, including its finances and operations outlook. Investors use them to assess the quality of debt issued by a company. In March of last year alone, as the coronavirus pandemic took hold of the United States, 12 utilities raised an average of $1 billion from bond markets. In 2019, electric utilities raised $90 billion from bond markets to transform their grids.

Why were credit ratings for electric utilities downgraded?

Electric utilities already had a negative outlook from leading ratings agencies heading into the pandemic. But its effects are not entirely responsible for the S&P downgrade. Instead regulatory issues, natural disasters, and the absence of a financial cushion to weather the pandemic’s uncertainties were responsible for the downgrade.

In an interview with Utility Dive, Gabe Grosberg, senior director at S&P Global Ratings, said the Exelon bribery scandal and the firing of FirstEnergy’s CEO and two executives in a bribery scheme was “mildly surprising.” “That’s not something we expect to be recurring within the industry,” he said. The two events resulted in downgrades for the utilities. The increasing intensity of wildfires in California also resulted in downgrades for three utilities operating in the state.

Meanwhile, delays in rate case filings due to the pandemic also weakened utility finances and ate into their financial cushion. “…it's hard to ask for a rate increase when so many customers are struggling," said Ray Tolentino, a Houston-based utility analyst told the S&P bulletin. "The optics don't look good."

What’s ahead?

The good news is that the worst may be over. Economic prospects for the world, and America, are brightening with the development of a vaccine. The International Monetary Fund (IMF) has predicted global growth of 5.5%, up by 0.3% from its October assessment. As the economy chugs back to normal, electric utilities should see an uptick in revenues due to increased demand from C&I customers.

The incoming administration has also pledged to fund an unprecedented amount of money towards climate change and green energy initiatives. That should help lessen the reliance of electric utilities on bond markets to fund their operations. A higher corporate tax rate should also provide more financial cushion for utility operations.

“One of the expectations is because the Democrats now control the presidency and control Congress, to the extent that they decide to go forward with the higher corporate rate, that will provide cushion in the funds from operations-to-debt measure that we expect will improve for the industry by about 100 basis points. And that's very material," said Grosberg.

In the near term, however, the future is bleak. According to Scotia Capital (USA) Inc. analyst Andrew Wiesel, near-term performance of utility stocks will be driven by existing economic conditions. “…performance may be primarily driven by macro sentiment, which is unfortunately sour despite strong fundamentals and attractive valuations,” he stated.

The dependence of utilities on coal and associated fossil fuels to generate electricity could also run afoul of the move towards ESG criteria for evaluating companies. Electric utilities positioned on the other side of this trade, such as NextEra Energy, will benefit.

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