Severe upward pressure on electric rates after a decade of stability has regulators, legislators, utility executives, consumer advocates, and myriad other stakeholders searching for solutions....
Rising Unit Costs & Credit Quality: Warning Signals
With increasing unit costs, the financial prospects and credit outlook for many utilities will depend on their success in passing along such costs to consumers.
- the state treasury or bring about other unfavorable consequences.
- While inflation and interest rates are likely to increase, Fitch does not currently anticipate an environment of double-digit interest rates.
- Utilities have reduced short-term and floating-rate debt balances over the past several years and refinanced much of their debt at low interest rates for terms of at least 7 to 10 years.
The Underlying Commodity Price Surge
Higher commodity costs broadly affect gas LDCs and electric utilities, with positive or neutral implications for a few companies with favorable energy positions, but unfavorable implications for many others. During 2005, U.S. natural-gas prices were elevated due to declining gas deliverability relative to demand, as well as the market correlation of gas prices to the price of oil and the geopolitical risk premium affecting the worldwide oil markets.
In late 2005, one-half of U.S. offshore continental shelf natural gas production remained out of production and shut-in, as a result of damage from hurricanes Katrina and Rita. Spot and forward prices for natural gas consequently surged. Producers are in the process of quantifying the extent of damage to U.S. gas reservoirs and infrastructure, and the potential for restoring the prior level of deliveries.
Forward- and spot-market prices for natural gas are expected to decline from the post-hurricane level if a substantial amount of production comes back on line, the current winter is mild to normal, and demand for gas declines materially in response to price increases. However, natural-gas prices could remain at an elevated level, at or above $7 to $8 per thousand cubic feet for some time because of declining production curves in the existing production areas and the rising consumption of natural gas for power generation in many parts of the United States. High natural-gas prices (relative to those prevailing between 1995 and 2002) will tend to influence higher market prices for related fuels, such as coal, uranium, and emission credits.
Meanwhile, individual utilities vary in their ability to pass on costs of purchased gas, fuel, and purchased power to consumers. In general, utilities with effective and frequent commodity price-adjustment mechanisms have greater protection in a rising fuel-price environment. However, during a profound increase in energy commodity prices, even utilities with the most protective commodity price adjustors are vulnerable to a sudden change in the rules and procedures governing tariffs. In rare cases, regulators have placed a moratorium on adjustments, deferred recovery for longer periods, or investigated prior utility management decisions, disallowing full recovery.
Rising Capital Investment
Capital spending is another source of rising unit costs—one that will persist over the intermediate and longer term, particularly for electricity distributors or integrated electric utilities.
In 2005, many investor-owned electric utilities began to boost their five-year forecasts for capital investment. Capital expenditures are targeted for reliability-driven distribution and transmission system upgrades and environmental compliance at generation plants in the 2006-2010 time frame.
These investments are not driven by increased units of demand but are largely undertaken to enhance service quality or meet environmental mandates. While a few utilities experience faster unit sales growth of 2.5 to 3