New York, June 17, 2003 — Moody’s Investors Service downgraded Duke Energy Corporation’s long term debt ratings, including its senior secured first mortgage bonds to A3 from A2, and its senior unsecured debt to Baa1 from A3.
Moody’s lowered the ratings of Duke Capital Corporation, including its senior unsecured debt to Baa3 from Baa2, and its commercial paper to Prime-3 from Prime-2. Moody’s also lowered PanEnergy Corp.’s senior unsecured rating to Baa3 from Baa2, and Texas Eastern Gas Transmission’s senior unsecured rating to Baa2 from Baa1.
Moody’s confirmed Duke Energy’s rating for commercial paper at Prime-2.
The rating outlook is stable for Duke Energy, Duke Capital, Texas Eastern, and PanEnergy. This concludes a review for possible downgrade that was initiated on March 31, 2003.
The ratings of Duke Energy Field Services (Baa2 sr. unsec.) continue to be under review for a downgrade.
Moody’s lowered Duke Energy’s ratings in response to our expectation that there will be a need for continuing financial support for subsidiary Duke Capital. Moody’s notes that Duke’s management has stated it has flexibility under the statutes governing Duke Energy’s ability to provide support to Duke Capital, as long as the utility maintains “adequate, efficient and reliable electric service” at “just and reasonable rates.”
Consequently, Moody’s believes Duke Energy’s leverage ratios and coverage metrics will come under some pressure as the company has made clear its intention to avail itself of this flexibility to support Duke Capital and its investment grade ratings.
The stable rating outlook for Duke Energy reflects the strength and stability of the Duke Energy utility system and credit metrics that appear to be solidly investment grade.
Moody’s lowered Duke Capital’s ratings due to an increase in debt that has outpaced cash flow growth, and a weak near term outlook for several sectors in which Duke Capital has made substantial investments.
Duke Capital’s credit profile has been pressured by decreased cash flows from its non-regulated businesses and higher uncertainty associated with Duke Energy North America (DENA) and Duke Energy International’s (DEI) cash flow contributions. Our greatest concerns reside at DENA. With approximately 16,000 MW’s of gas-fired generation, located in a number of regions of the country, DENA is expected to maintain a significant presence in the merchant energy market and will remain exposed to wholesale market spark spreads for several years. Our ratings, and financial forecasts, reflect a conservative outlook for DENA, and Moody’s anticipates underperformance of this business for several years, absent a significant and sustained improvement in the wholesale generation markets.
Moody’s noted a fundamental challenge for DENA’s gas-fired merchant generation, with an adverse natural gas spark spread in most regions, and continued expectations for oversupply and high reserve margins. These challenges will pressure management’s ability to generate revenues significantly in excess of its “hedged” or “low-risk” gross margin, without which, the business will most likely operate at a loss.
Managing its commodity exposures and executing a trading and marketing strategy with a high degree of success is a key factor for DENA to meet its gross margin targets. Duke’s management has indicated that maintaining investment grade ratings is a key element to this strategy, impacting the level of margin postings, and the available notional size and term of trading transactions.
Other areas of credit focus for Duke Capital include its real estate operations (Crescent) and its portfolio of international power and gas pipeline investments (Duke Energy International, or DEI). While Crescent has performed well in recent years, it is vulnerable to a potential softening in certain commercial and suburban market sectors.
Moody’s views Crescent as a potentially non-core asset with significant realizable value in its property portfolio. To date DEI has performed according to management’s expectations. Moody’s notes; however, that these projects, located in Latin America, Asia-Pacific and Europe, are subject to geo-political and currency risks, as well as the operational risks associated with the businesses. Moody’s views most of DEI’s investments as non-core assets, many of which are financed on a non-recourse basis at the project level.
The stable outlook of Duke Capital reflects credit supportive actions by management, including exiting proprietary energy trading and boosting Duke Capital’s equity base, as well as Moody’s expectation that Duke Energy will continue to provide support as needed to underpin Duke Capital’s creditworthiness and financial flexibility.
Duke Capital’s pipeline and gas distribution operations exhibit reasonably predictable cash flow growth, and represent the majority of EBIT and cash flow generation, but a much smaller portion of assets and invested capital. The pipelines are currently capitalized within their FERC and other regulatory authorized capital structures and exhibit strong operating characteristics, such as contracted capacity, long-term contracts and expansion opportunities. Furthermore, Moody’s notes that the Canadian pipeline and gas distribution operations have authorized capital structures which allow higher degrees of leverage than most US counterparts.
The downgrade of PanEnergy and Texas Eastern Transmission reflects the downgrade of Duke Energy and is consistent with Moody’s standard notching approach for gas pipeline subsidiaries that lack substantial ring-fencing provisions. The stable outlook for PanEnergy and Texas Eastern Transmission incorporates the expectation that Duke will not further lever these regulated pipelines as a means to provide cash to other Duke units.
Duke Energy and Duke Capital have sizable cash positions. Duke has had success refinancing its bank credit facilities, albeit at lower targeted total amounts. Moody’s is comfortable with the adjusted available bank capacity, and notes that the commercial paper programs at both Duke Energy and Duke Capital have been substantially reduced. Unexpected, sizeable movements in commodities, given the trading and marketing operations at Duke Capital, may result in substantial collateral calls. The company has taken steps which reduce its exposure to collateral impacts on its liquidity, such as exiting proprietary trading and instituting a more rigorous set of financial controls and risk mitigation procedures as an explicit element in its over-all risk management and financial strategy.
Duke Energy is headquartered in Charlotte, North Carolina.