Financial experts often depart from standard financial principles and practices in recommending the appropriate rate of return for public utilities. But ratemaking draws from many fields, not just...
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generation as a largely regional commodity business, with power pools, bilateral
contracting, high risks, and high rewards. Financial requirements will be substantially lower than for the traditional integrated utility.
Trans. & Distr. By contrast, companies involved only in the transmission and distribution (T&D) segments should present a lower risk profile, says D&P, with more stable cash flows, lower quantitative protection measures, and a higher level of debt capacity. D&P expects average ratings in transmission and distribution (T&D) to run higher than for generating companies.
One important difference from generation, says D&P, is that the T&D affiliate will start the game with a long list of historical customer relationships, broad name recognition, usually a favorable brand image, and as a result, some level of market franchise.
S&P assumes that transmission (high-voltage lines) will remain regulated by the Federal Energy Regulatory Commission, with a rate base and rate of return, thus decreasing risk and requiring higher financial requirements for any given level of rating than the current financial benchmarks for integrated utilities. At the same time, it assumes that distribution will be made up of at least two or three other businesses. A wires business will continue under state regulation with more use of incentive pricing. Other businesses will include marketing and service-related ones. Risk positions will vary substantially among distributors, says S&P.
Electric vs. Gas. D&P predicts credit ratings in the "AA" range for electric distributors. It describes a pure-play electric distribution business as similar in risk profile to today's natural gas local distribution company (LDC).
That comparison might prove unfruitful, however, as gas utilities, which have enjoyed a price advantage over electricity during the past decade, slowly respond to changes in electric markets. At Moody's, for example, senior analyst Alexandra S. Parker notes that some gas utilities might prove vulnerable to losses brought about by electric competition, depending on such factors as customer mix, location, size, and cost position, plus the pace of change in the local regulation of both electricity and natural gas.
In fact, Moody's suggests that increasing competition between natural gas and electric utilities will place local gas distributors at risk of revenue loss as customers leave the system, or of margin deterioration as rates are discounted to retain at-risk customers. Perhaps of even more significance to the bondholder is that the convergence of the end-use energy markets likely will spawn greater merger and acquisition activity between the electric and gas industries. %n1%n
Moody's concludes that over the next decade, competition, not only from pipelines and independent gas marketers, but also from electric and combination utilities, will join with mergers and acquisitions between the electric and natural gas industries and with more traditional risk factors, such as changing regulation and diversifications into nonenergy-related marketing businesses, to erode average credit quality. Although the average senior debt rating for pure natural gas distribution
companies has been relatively high and quite stable, remaining between "A2" and "A3" since 1979, the rating outlook for the industry taken as a whole is negative, says Moody's.
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