For years, low natural gas prices have helped keep customer bills down, which led many state regulators to take an amenable approach to utilities' pursuit of ambitious capital spending programs recovered through rate hikes. But regulators may be more hesitant to add to customers' burden, experts said, with the utility sector's pivot to renewable energy depending on approvals to invest billions in new infrastructure amid soaring natural gas prices.
"Rate case activity has been fairly robust over the last decade or so" to account for decarbonization as well as replacement and modernization programs, cybersecurity initiatives and severe weather damage, according to Lillian Federico, research director at Regulatory Research Associates, a group within S&P Global Commodity Insights.
But while lower fuel costs and interest rates once offset those increased revenue requirements, the reverse trends will "bear on regulators and [force] them to make difficult choices about how to balance ratepayer and shareholder interests," Federico said.
Regulatory 'fatigue'
That is already becoming an issue for Consolidated Edison Inc., whose soaring New York City utility bills, driven by wholesale power and gas prices, prompted New York Attorney General Letitia James in February to respond to customer complaints. The increased public scrutiny comes as Consolidated Edison Co. of New York Inc. has filed requests with state regulators seeking $1.2 billion electric and $502.7 million gas rate increases to fund investments in energy efficiency, renewables, electric vehicles and clean heat.
S&P Global Ratings analysts wrote in a March 8 note to clients that while regulatory lag will continue to drive utilities' aggressive rate filing strategies, "persistent rate case filings can lead to regulatory fatigue" and heighten regulatory risk.
Bond analysts at CreditSights also noted regulators may not be as willing to approve "record level capex programs ... which in turn thus has the potential to put the across-the-board 5[%]-7% EPS growth rates at risk."
Customers of regulated utilities with portfolios reliant on gas, including Southern Co., CMS Energy Corp. and Sempra, "will likely see a disproportionate increase in their bills," according to Ratings, as will pure-play transmission and distribution utilities such as Con Edison, Public Service Enterprise Group Inc. and Exelon Corp. that operate in gas-heavy wholesale markets.
Ratings said the impacts on the North American utility sector of rising commodity prices, inflation and higher interest rates are likely to result in a widespread "marginal weakening of credit quality."
Despite the risks to customer affordability and rate hike approvals, "utilities should be mostly insulated from price spikes," according to Scotiabank, though analysts there acknowledged regulatory approvals for discretionary projects could become tougher to achieve, which would impact short- and medium-term earnings.
Inflation, interest rates
Inflation could hit companies like NextEra Energy Inc., PG&E Corp., Avangrid Inc. and NiSource Inc. particularly hard because they are spending more capital than industry peers, according to Ratings.
Interest rate hikes are likely to have the greatest impact on utilities that rely most on variable rate debt, Ratings said, a list that includes Algonquin Power & Utilities Corp., NextEra and PNM Resources Inc. The credit rating agency noted utilities are unique in that they operate with negative discretionary cash flow, a reflection of the sector's high capital spending and dividend payouts. Since utilities fund most of their negative discretionary cash flow with debt and due to regulatory lag, rising interest rates could cause utilities operating with a relatively high degree of negative discretionary cash flow to see a slight weakening of financial performance.
"Historical avenues to reducing debt, such as common equity issuance, may not be as realistic in 2022 given equity market volatility," Ratings analysts wrote. "We expect that utilities will take other steps to reduce leverage, including asset sales and hybrid securities."
Ratings economists expect the Federal Reserve will implement six rate hikes in 2022. But with rising energy prices stemming from Russia's invasion of Ukraine making already soaring inflation climb higher, the odds of the rate-setting Federal Open Market Committee approving a "supersized" rate hike of 50 basis points at its next meeting March 15-16 have tumbled below 5%, according to the CME FedWatch Tool, which measures investor sentiment in the Fed funds futures market.
Regulatory Research Associates is a group within S&P Global Commodity Insights.
S&P Global Commodity Insights produces content for distribution on S&P Capital IQ Pro.