Power blackout not expected to affect near-term credit quality of electric utilities

However, Moody’s states that long-term implications loom

New York, Sept. 4, 2003 — In a newly released special report, Moody’s Investors Service says that the financial implications of the North American blackout are not expected to influence the credit quality of the electric utility industry at this time.

However, the rating agency notes that several issues could impact credit quality in the future, among them, potential changes in public policy and increases in capital expenditure programs and debt financing.

Moody’s sees no change in credit quality over the near term as a result of the power failure. In the worst of circumstances, the companies have lost one or two days of margins, incurred increased operating expenses that will be recovered through the regulatory process, and while the extent of the damage to power facilities is not yet fully known, capital expenditures for recovering facilities are not expected to be onerous.

Moody’s, however, cautions that a series of factors could have credit implications over a longer term. The primary credit driver that could develop from this experience may be the financial implications of substantive changes in national policy, particularly regarding network reliability.

“While each of the companies and network operators appears to have responded as intended, none appeared to have been fully aware of the events outside of their own control area and thus was not aware of the danger they faced,” says Senior Vice President Stephen Gutkowski, who co-authored the report.

“It seems likely that the FERC will renew its call for the creation of larger RTOs with the ability to view network events over large geographic areas.”

By providing clear evidence that the reliability of the North American electricity grid could be improved the 2003 power failure will add impetus to debates over the direction and pace of industry restructuring and the proper balance between competition and regulation. With elected officials eager to demonstrate some kind of response, there may be significant changes in public policy and regulatory oversight.

“For example, Congress may be more likely to act on pending legislation related to the electric industry, which would involve broader issues than solely promoting greater reliability of the electricity grid. The perceived need for greater coordination across the grid may also strengthen the Federal Energy Regulatory Commission’s position in the debate over the scope of the roles of state and federal regulators in the electric sector,” says Gutkowski.

Also on a cautious note, higher expectations for system reliability will lead to some level of increases in capital spending. Whether or not the investigation of the causes of the blackout indicates that higher capital spending might have prevented the power failure, public pressure for tangible evidence of action to prevent a recurrence will lead to increased expenditures on the grid going forward.

“The magnitude of this spending is not yet known but could be very substantial if there is a strong and sustained push from governments and regulators,” says Vice President Jim Hempstead, who co-authored the report.

Moody’s expects any increases in capital spending resulting from the aftermath of the blackout to be initially financed with debt, as is typical for most capital expenditures in the utility sector. While regulated entities will be expected to obtain a return on their investments through rates, higher debt levels could reduce financial flexibility for some utilities.

“This could also lead to reduced capacity to make dividends to holding companies, potentially adversely affecting some holding companies that are heavily reliant upon utility subsidiaries to service holding company debt,” says Hempstead.

Although government-owned electric utilities are subject to a different regulatory structure, most of the broad potential implications of the outage discussed here apply to government-owned utilities as well as investor-owned utilities, as the government-owned utilities are extensively integrated with private sector utilities.

“While an aggressive public review of the blackout will be ongoing, the short-term implications of the power failure were not material to the industry and, as a result, rating changes are not expected,” say the analysts.

Source: Moody’s Investors Service

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