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Fitch: U.S. Power and Gas Sector Resists General Economic Slowdown

Posted on: Wednesday, 12 December 2007, 12:00 CST

Fitch Ratings' outlook for U.S. utilities is stable for the coming year, while the business environment anticipated for U.S. non-utility power generators is generally favorable. Fitch's outlook for the U.S. Power and Gas sub-sectors are as follows:

-- Stable outlook for U.S. investor-owned electric and gas utilities, interstate natural gas pipelines, and public power entities in 2008

-- Negative longer-term outlook for investor owned electric utilities

-- Positive outlook for U.S. wholesale power generating companies

-- The one-year outlook for midstream gas processors is positive, while the longer term outlook is stable.

-- The outlook for retail propane distributors is negative in both the one-year and longer time frame.

Fitch believes the 2008 credit outlook for the U.S. utilities, power and gas sector will be relatively unaffected by the U.S. economic slowdown driven by weakness in housing and financial markets. The power and gas sector has retained relatively open access to credit and capital markets since it is viewed as a defensive sector, but credit spreads have widened. There is ample liquidity.

The outlook is influenced by high gas inventory as the heating season begins. But in the next several years, demand for gas is likely to rise as a result of increasing reliance on gas as for power generation. Gas price volatility, which has recently been relatively modest may accelerate once again increasing the risk of gas price spikes in the intermediate and longer term.

Key drivers of the stable near-term outlook for investor owned electric utilities are the focus of capital expenditure budgets on mandated transmission reliability and environmental compliance projects considered to have reasonable assurance of timely cost recovery; strong liquidity and continuing access to capital markets; the prevalence of business strategies focused on core utility activities and robust natural gas storage levels heading into the winter heating season. While the overall 2008 outlook is stable, there are pockets of higher risk. Fitch views risks as elevated in restructured states in which the highest cost of generation sets power prices, or is scheduled to begin to set prices following the expiration of rate caps/freezes and states in which rates have been flat for a number of years. Legislative debate over retail electric market structure in Ohio is beginning to heat up and changes in utility law have recently been or are contemplated in Michigan, Pennsylvania, Maryland, and Texas.

Fitch's negative one- to five-year term electric IOU sub-sector view partially stems from our concerns over electric utilities' abilities to continue obtaining timely and full recovery of increasing capital and operating costs following sequential rounds of rate adjustment filings prior to the peak of spending on new baseload capacity expected to occur in the next decade. The uncertainties over the timing and shape of limits on greenhouse gases as well as any national renewable portfolio standard increases credit risk for the electric utility segment.

Fitch's view of the business outlook for the wholesale power generation (genco) group is positive. Electric power reserve capacity margins are expected to decline, driven by limited new capacity additions and continued increases in power demand ranging from 1% to 2.5% depending on the region. Over the next five years, additions to generating capacity are expected to be relatively limited leading to an expansion of heat rates and spark spreads in most regions. Capacity revenues are also likely to be a significant contributor to generators' cash flow. Independent gencos with speculative grade ratings are candidates for improvements in their credit ratios and ratings; however, affiliated gencos with investment-grade ratings have above-average event risk for leveraging transactions, merger, consolidation, or spinoff. Given the low current leverage and light covenantal protection characteristic of the higher-rated affiliated generating companies, bondholders of these companies are exposed to changes of corporate or financial strategy.

Given the current robust fractionation (frac) spreads for natural gas processing, Fitch's expectation is that short-term financial performance for virtually all phases of the midstream sector will be strong, although cyclical improvements in margins and cash flow will not necessarily translate into higher credit ratings. Fitch anticipates that midstream services will continue to experience significant new investments and cash flow growth over the near term, consistent with ongoing new investments by upstream producers. While the same holds true for new assets serving offshore production facilities, Fitch notes that these assets have higher execution and weather-related risks as well as substantially higher insurance costs. Cash flow stability has increased in recent years as a result of greater reliance on 'fee-based' contracts. Beyond 2008, the midstream credit outlook is stable, reflecting uncertain longer-term commodity prices and the resulting effect on gathering and processing margins and volumes.

Fitch's view of inter-state pipelines is stable. Creditors of interstate natural gas pipelines continue to benefit from the sector's generally stable cash flows, moderate to low-risk operations and strong financial performance across the sector. Interstate pipelines demonstrate only limited sensitivities to external factors due to the fixed-capacity payment obligation of shippers under volume-insensitive FERC-regulated rates. Fitch believes MLP activity will continue to be robust in the inter-state pipeline and midstream sectors next year.

The issues facing public power utilities are similar to those explained above for the investor-owned electric sector. Specific to the outlook for coops and public power are: the higher rate of demand growth in some developing regions with resultant higher capital spending needs; implications of the mortgage crisis upon municipal tax collections and the possible pressure for transfers from municipal utilities to the general fund.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.

Source: Business Wire

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