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S&P report studies credit crisis implications to power companies

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20 October 2008 — Regulated electric and gas utilities and power companies have not been immune to the devastatingly rapid consequences of negative market sentiment.

The rated U.S. regulated utility and merchant power companies’ total debt outstanding is $505 billion. As of June 30, 2008, these companies’ balance sheets contained an aggregate of more than $31 billion of cash and short-term investments.

According to a report by Standard and Poor’s titled “The U.S. Utility And Power Sector Appears Well Positioned To Manage Refinancing Requirements,” most, if not all, power companies should be able to refinance pending maturities despite the unsettled state of the credit market.

Recent high-profile events like the almost overnight loss of investor confidence in Constellation Energy Group Inc. that coincided with the final days of Lehman Brothers Holdings Inc. and the sudden termination of a “sleeving” arrangement (a guarantee by one party, including the posting of collateral, to support specific obligations of another party) between Reliant Energy Inc. and Merrill Lynch & Co. Inc. have raised concerns about the industry’s overall ability to handle stress.

However, the underlying credit fundamentals of the utility and power industry do not support these concerns, at least in the short to medium term.

“That’s the conclusion we reached after we reviewed the cash position, pending debt maturities, and available revolving credit capacity of the investor-owned electric, gas, and water utilities and the merchant power industry,” said Standard & Poor’s credit analyst Richard Cortright.

Although the utility industry’s credit quality and that of diversified power companies is solidly investment grade and our near-to-intermediate-term outlook is stable, continued deferral of costs coupled with the current recessionary economic conditions and the associated uncertainty of U.S. and global financial markets will erode financial metrics. If these conditions continue for an extended period, they could threaten ratings.

In June 2008 Duke Energy Corp. issued $250 million of senior unsecured debt due 2013 at 5.65 percent. This is almost exactly the same coupon as PECO Energy’s secured issue of September, but the Duke paper is rated BBB+.

Regarding speculative-grade companies, especially the merchant power generators, Standard & Poor’s believes that risks associated with near-term refinancing requirements are manageable given ample sources of liquidity and limited maturities.

In addition, several utilities successfully “tested” the availability of their bank facilities during Lehman’s decline.

Two companies have gone much further: Duke Energy drew down $1 billion off its $3.2 billion facility to ensure access to sufficient liquidity now rather than risk a further weakening of the markets generally; and American Electric Power Co. Inc. drew down $1.4 billion under its existing credit facilities to increase flexibility and provide a liquidity bridge until the capital markets improve.

At the same time, however, capital expenditure projections are significant, perhaps unprecedentedly so.

The regulated electric utility sector alone estimates capital spending needs in the range of $180 billion in 2009 and 2010.

The merchant sector’s capital expenditure plans are limited principally to maintenance and certain environmental commitments, which can all be funded from internally generated funds.

Standard & Poor’s expects that companies may adjust their current spending estimates, perhaps significantly, because of the current economic crisis.

These adjustments will not be so much to reduce or eliminate the expenditures permanently as to defer them for some indeterminate period.

In the meantime, the companies will instead direct expenditures, on a much lower scale, to maintaining what in many instances is a rapidly aging and increasingly unreliable infrastructure rather than on the more expensive option of building new plant.