Gas, Retrofits & Upgrades

Fitch U.S. utility briefing: ‘Daylight, but not much sunshine’

NEW YORK, June 26, 2003 — There are signs of improving credit signals in the U.S. utility sector, Fitch Ratings’ Global Power team noted in a five-city credit briefing which ended in San Francisco recently.

“Recent rating actions have been rather like the New York weather for most of this year – we’ve seen daylight, but little outright sunshine,” said Richard Hunter, Managing Director Global Power, Fitch Ratings. The first half of 2003 saw downgrades outpace upgrades by 3.5:1, although this compares favorably with over 15:1 during 2002.

Integrated Utilities Stabilizing

The speakers, some of the senior participants in Fitch’s Global Power Group, highlighted developments that would lead to rating movement on a number of key companies, and the impact of secured debt on a number of high-profile speculative grade credits. “We are still on track somewhere between our middle case and our optimistic case for 2003,” said Rob Hornick, Senior Director of Investor-Owned Utilities, Global Power, Fitch Ratings.

Fitch Senior Director Ralph Pellecchia also discussed the underlying stability of the gas pipeline sector, where upgrades have outnumbered downgrades since the start of the year, largely following ownership changes.

Wholesale Energy Companies Still Under Pressure

However, although market sentiment has improved across the board, from very weak levels, a number of the lowest-rated issuers have a long road ahead to execute on strategies revised during 2002. For some of the lower speculative-rated entities, access to secured bank loan capacity has been crucial.

The statistics here are stark, as Fitch Senior Director Sharon Bonelli noted: “In the twelve months ending December 2002, the volume of problem syndicated loans to the oil, gas and utility sectors almost tripled to $32.5 billion, by Federal Reserve Board regulatory standards. More than half of this figure was in the FRB’s weakest categories – $17 billion – and we think most of this exposure was in the wholesale power and gas sector.”

Wholesale Markets

Secured bank facilities have in many cases only bought the lowest-rated companies two to three years to repair their balance sheets. In the absence of compelling deleveraging strategies, and on the crucial question of whether wholesale energy profitability might recover within that timeframe, Fitch Managing Director Ellen Lapson introduced Fitch’s wholesale power price model.

The regional power market models, maintained in cooperation with Henwood Energy Services, have helped Fitch refine its views on price dynamics in five key regions and over 65 sub-regional pricing zones throughout the U.S. and Canada.

Fitch is using the resultant price forecasts to test assumptions about spark spreads, capacity utilization rates, and cash flow from merchant operations for rated issuers.

“The base case and alternate low-case forecasts of future real-time power market prices in major regions and sub-regions are used to quantify the potential financial implications of long or short commodity positions affecting companies in the power and gas sectors – unhedged positions of wires companies and retail providers, integrated utilities, generation companies and wholesale energy providers,” said Lapson. “Going forward, we are planning to use the market forecasts as an input to the estimated asset recovery values we use when rating distressed entities,” said Bonelli.

Clearing Houses

Despite the recovery in access to the bank and bond markets for issuers, new clearing house structures are still not making a significant difference to liquidity needs. “In other markets, clearing has reduced collateral needs by over 80%,” said Denise Furey, Senior Director, Fitch Ratings. “But practical problems – ever-changing clearing products, short or no track records for power clearing as a concept, and the specific challenges of power as a commodity – have all contributed to keeping actual clearing activity to a very low level.”

Common questions asked during the credit briefings included the effectiveness of ring-fencing to protect the credit of utility subsidiaries, and the related impact of ring-fencing to reduce flexibility available to parent holding companies; the implications of relative recoveries on ratings of distressed companies; the anticipated level of new construction and retirements of generating units forecasted for the next five years; and factors that could bring about natural gas prices higher than or lower than the base-case or low case forecasts.

Presentations from Fitch Global Power’s Summer 2003 Credit Briefing – “Movers and Shakers”, “Regional Power Market Dynamics”, “Wholesale Energy and Clearing Houses”, “Investing in Gas Pipelines” and “Secured Credit Facility Analysis” – are available on the Fitch Ratings web site at www.fitchratings.com from the Global Power sector page under Special Reports.

Fitch will also be publishing its Global Power Quarterly Newsletter in the week beginning July 7, 2003, which will also be available at ‘www.fitchratings.com’ or by calling Lauren Cozier at 212/908-0500.