NEW YORK, March 19, 2002 — Moody’s Investors Service has assigned a long-term issuer rating of A1 to ERCOT, the independent system operator ( ISO) that administers the 37,000 mile-power grid in the ERCOT region.
ERCOT expects to issue long-term debt in late April 2002 to refund outstanding commercial paper notes used to fund initial start-up costs. ERCOT is a Texas non-profit corporation governed by an independent stakeholder board.
The ERCOT region encompasses about 85% of the electrical load in Texas and has an overall generating capacity of 70,000 MW. Portions of Eastern Texas, West Texas, and the Texas panhandle are not included in the ERCOT region. ERCOT is not regulated by the Federal Energy Regulatory Commission (FERC) since the ERCOT region has no synchronous interconnection across state lines.
The Public Utility Commission of Texas is ERCOT’s principal regulatory authority.
The credit rating reflects: the well-established and accepted role ERCOT has maintained in the electric industry in Texas; the essential services ERCOT provides in establishment and enforcement of protocols for operation and reliability of the transmission system in the ERCOT region; the low risk nature of ERCOT as both commodity risk and counterparty risk are not borne by ERCOT; ERCOT’s financial obligations are well secured including being supported by a state statute that requires ERCOT’s costs, which are primarily administrative expenses such as computer operations and staffing, to be fully recoverable by a fixed administrative fee assessed to qualified scheduling entities (QSEs); the size, stability and liquidity of the ERCOT power market represents a key factor since it minimizes price and reliability risk as the Texas market deregulates; and the weighted average credit quality of ERCOT QSEs and the credit standards for new QSEs.
Well established and accepted role in Texas electric industry
ERCOT, established in 1970, has been serving an important role for many years in providing transmission oversight.
This history distinguishes ERCOT from other independent system operators that were established elsewhere in the U.S. in the 1990s in response to the FERC regulations that have implemented wholesale power market restructuring. ERCOT has been responsible for facilitating the reliable operation of the power grid according to the safety and reliability standards set by the North American Electric Reliability Council.
Moody’s believes that ERCOT has had a strong record in executing its mission in the past. In response to Texas’ adoption of wholesale electric competition in 1995, ERCOT has evolved as an organization to accept the role of independent system operator and to enhance transmission system reliability and wholesale market access.
In 1999, Senate Bill 7 established ERCOT’s eligibility to serve as the independent organization in the ERCOT region. The Public Utility Commission (PUC) appointed ERCOT the independent organization in the ERCOT region with several areas of major responsibility including establishment of the infrastructure to support retail choice, security operations of the bulk power market; facilitation of the efficient use of the transmission system ensuring reliability; and coordination of future transmission planning.
Full implementation of the retail electric market began January 1, 2002 with ERCOT continuing its duties as an ISO and undertaking expanded responsibilities to manage market restructuring . ERCOT will not function as a power pool nor have responsibility for energy pricing or matching buyers and sellers, although it will undertake to arrange ancillary services to ensure reliability, to the extend QSEs do not self-arrange such services.
While ERCOT has evolved, it is apparent that the transition to the restructured electricity market in Texas has benefited from the experience and organizational strengths ERCOT has brought to the market transition tasks it has had to manage.
Financial obligations should be well-secured due to low risks of transmission role and charge for essential service
The transmission oversight role that ERCOT performs is a critical role in the delivery of electricity in the ERCOT region of Texas. Key to the credit rating is the essential function ERCOT performs. No other entity can compete with ERCOT to perform such services due to the nature of the services provided, the high startup costs involved and also due to the state statute and PUCT order that assigns the ISO role to ERCOT.
Moody’s believes that this essential service is a major factor in bond security since the charges paid by customers are more certain to be made when required even in a bankruptcy of the utility provider. ERCOT also has the legal authority to terminate a scheduling entity’s future ability to participate in the ERCOT market if it fails to pay ERCOT its required charges to recover its costs.
Furthermore, to the extent that any one QSE defaults on a weekly payment obligation, ERCOT has settlement procedures that allow ERCOT to deduct its full fee before paying out to QSEs who are net creditors for that week. Furthermore, the administrative fee charged by ERCOT to recover its administrative and debt service costs is very small compared to the overall retail charges on customer bills.
The administrative charge in 2002 is 22 cents/mwh., compared to the average price of energy in the $25 to $35/mwh range.
Unlike other ISOs formed in the U.S., ERCOT should remain the ISO for most of the state’s electrical grid. The Midwest RTO, for example, continues to expand and contract as it develops into the transmission operator for a large part of the midwestern U.S.
ERCOT’s future organizational structure appears to be more certain. Merging of the ERCOT ISO into a multi-state regional transmission organization (RTO) appears unlikely: ERCOT’s interconnection to the U.S. electrical grid has been evaluated in the past, and the capital requirements to construct such an interconnection is estimated to significantly exceed the economic benefit of such an interconnection.
Stability and liquidity of the Texas market is a positive factor reducing the potential credit risk of deregulation
Deregulation of the electricity industry in the U.S. has taken a tortuous path for many utilities and may take its toll as well on the Texas market as it restructures. However, several significant factors are weighing heavily in the direction of a less uncertain path including the size, stability and liquidity of the existing Texas energy marketplace.
The ERCOT region has had a sound reserve margin strengthened by new generation facilities built since 1995 which reduces the risk of price spikes and shortages. Another key factor which eliminates a potential source of market disruption is that less than 1% of the power sold in Texas is imported given the limited interconnection.
The relative stability of the Texas market would be a positive factor since it reduces the price and deliverability risk for participants which limits any potential effects on ERCOT operations.
ERCOT has undertaken a broader role in the restructured market. It serves as the supervisor of the development and operation of the competitive retail electricity market in Texas that began allowing customers choice of power supplier in January 2002.
ERCOT is the centralized registration agent for retail customers in the entire state charged with the responsibility of administrating customer switching of supplier. In the first three months of the retail choice program in 2002, 170,000 customers have switched retail electricity supplier. ERCOT has no financial responsibility in this role other than administrative costs to provide the function.
ERCOT participants weighted credit quality is in the A-rating range
Another key factor in the issuer rating assigned to ERCOT is that the bulk of the transactions taking place in ERCOT (almost 90%) involve six electric utilities that Moody’s calculates have an A3 weighted average credit rating.
The financial characteristics of the participants strengthen the credit quality of the overall ERCOT membership which consists of 51 cooperatives and river authorities, 33 municipals, 8 investor-owned utilities, 19 independent power marketers, 11 independent generators, and 8 independent retail electric providers.
Another important credit factor is that ERCOT has established creditworthiness standards for existing and new qualified scheduling entities that include minimum financial ratios and alternative forms of credit that must be A or better rated.
Over time Moody’s believes this credit monitoring function will be more important as an increased number of participants enter the market. ERCOT’s credit monitoring procedures will more than likely be tested and may be a credit factor should the weighted credit quality of ERCOT weaken.
Financial record satisfactory; forecasts reflect limited budget pressure
ERCOT’s financial operations audited by Pricewaterhouse Cooper reflect the stable nature of its not-for-profit business. ERCOT operations are funded by the per megawatt hour charge assessed on load of the qualified scheduling entities. Revenues are a function of load volume and rate changes.
Financial forecasts for 2003-2004 indicate a small rate increase to support operations. ERCOT has maintained satisfactory liquidity levels with satisfactory ending cash balances.
In July 2000, ERCOT issued $110 taxable Commercial Paper Notes (rated P-1 by Moody’s) with letter of credit support that matures July 13, 2002. The commercial paper note proceeds were used to develop the systems to manage the grid and business transactions.