Assessing the Regulatory Environment
UNDERLYING THE INVESTMENT-GRADE CHARACTER of the U.S. investorowned electric utility industry rests the monopolistic structure of the industry and the framework of state rate-setting jurisdiction. These two features propel utilities into a credit stature that few corporate industries enjoy. Indeed, without such an underpinning, the industry would exhibit a credit profile that is more speculative grade in nature. For an industry that is among the most capital-intensive in the United States, failure to maintain investment grade could have significant upward cost implications.
The most common Standard & Poor's Rating Services corporate credit rating among electric utilities is BBB, which also tends to be about the average for the industry and is two notches above speculative grade. The ratings for the industry range from a high of AA- (Madison Gas and Electric) to a low of BB (PNM Resources and its two utility subsidiaries). NV Energy, its two utility subsidiaries, and Puget Energy are the only other non-investment-grade electric utility companies, all of which are rated BB+. At the time of the last major utility-led infrastructure build-out period in the 1970s and '80s, ratings were more typically at the A to AA- levels.
With such profound influence over the creditworthiness of an industry, a state's regulatory environment is the central credit factor in driving our analysis of utility creditworthiness. But the analysis does not end at the public service commission; rather, it extends to the state's judicial and legislative realms as well, which can at times dramatically affect the environment in which regulators make decisions.
Indeed, there are several instances in recent years where the interference of governors, legislatures and attorneys general has significantly influenced the outcomes of rate-making procedures. Further intervention of this nature is a near certainty as utilities across the country submit an increasing number of rate increase requests to address exceptionally heavy spending requirements. To minimize political intervention as much as possible - which we recognize as a near impossibility, particularly with a vulnerable economy and high unemployment - a sustained, collaborative and open working relationship among the principal vested interests will be critical to the execution of corporate, environmental and public policy initiatives. Utilities are vehicles for all three.
Standard & Poor's considers regulatory risk as it does any other risk: one that each utility must manage to the best of its ability. We recognize that different jurisdictions represent different degrees and characteristics of risk, but what this implies is that management must adjust its regulatory strategy to meet those unique challenges.
So what is Standard & Poor's view on the credit-supportive character of the current regulatory environment? We, of course, rate individual utilities, so what is most important to our analysis is the influence of a state commission on the specific utility in question. Having said that, we view most favorably those commissions that establish rates that reasonably reflect the costs incurred by a utility, including a return on equity, and where timely adjustments to these rates are made to recognize changes in costs.
Various legislative actions and regulatory mechanisms that support such an environment include future or adjusted test years, interim rate authority, decoupling structures, and expense riders. By this measure, we believe that public service commissions continue to be reasonably supportive despite frequently lower authorized returns. Moreover, in some states, such as Michigan, Virginia, Pennsylvania and Illinois, legislatures have enacted very supportive laws that require future test years, time constraints on commission decision making, and even formula rates of return.
Standard & Poor's recognizes that the real tests lie ahead, when federal environmental mandates and consequent spending requirements are more certain, when state renewable portfolio standards begin to command heightened expenditures in earnest, and when an aging infrastructure reveals its vulnerability in more than anecdotal ways.
Even with the open and collaborative dialogue noted earlier, rapidly increasing consumer resistance to rising bills will test regulatory support for timely and perhaps even full rate recovery, a preference for expense deferrals may develop, and a proclivity for less competitive authorized returns will almost certainly prevail. Such a turn of events would likely result in a shift of our stable outlook on overall U.S. electric utility credit quality to negative.
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