When Old Dominion Electric Cooperative announced recently that by 2030 it plans to reduce its carbon intensity by 50% relative to 2005 levels and that by 2050, the utility is targeting achieving net zero carbon dioxide emissions, it joined a growing number of electric cooperative utilities that are pursuing decarbonization strategies. We view these decarbonization plans as moderating environmental exposures flowing from electricity production, which could help support our ratings on these utilities. Similarly, we associate positive governance characteristics with utilities that proactively plan to reduce greenhouse gas emissions to benefit the environment and the well-being of people and businesses within the shadow of the utilities' power plants. Although ESG social exposures to health and safety risks could improve with decarbonization, the cost of decarbonizing could lead to higher retail electric rates and affordability issues, which could exacerbate social risks.

We also believe a subset of cooperative utilities face an uphill road to decarbonization, which we view as constraining the ratings we assign to these utilities. The hurdles this group faces include acute dependencies on coal that would require a costly and extensive revamping of generation fleets to achieve decarbonization, and the economic and political fallout of plant closures relating to workforce and tax-base reductions. In some cases, affordability issues that flow from weak service territory income levels could constrain the ratemaking flexibility needed to pay for decarbonization initiatives and compound the operational obstacles these utilities face, which could perpetuate environmental and social risks.

Fuel Burn Corresponds To Location

Many electric cooperative utilities operate in the South and Midwest regions that the Department of Energy's Energy Information Administration (EIA) identifies with the highest levels of coal-fired electricity generation in the U.S. (chart 1). Like their neighboring utilities within these regions, cooperative utilities rely on carbon-intensive generation fleets to produce the electricity they sell. Seven of the eight largest electric cooperative utilities, as measured by megawatt hours of electricity production, operate in the states EIA identifies as the South and Midwest regions. The eighth, Tri-State Generation and Transmission Association, operates in the West region (chart 2). Except for Oglethorpe Power Corp., the balance of the eight largest cooperative utilities relied on coal for at least 49% of 2019's electricity production, and some, significantly more.

Chart 1

Chart 2

The historically high carbon intensity among many cooperative utilities underscores the significance of their decarbonization efforts as a departure from past practices. However, while electric cooperative utilities' initiatives to decarbonize are significant, such actions are not exclusive to the cooperative sector. Many public power utilities and investor-owned utilities have committed to significantly reduce greenhouse gas emissions in stages to advance environmental goals or comply with state directives.

Decarbonization Is Inevitable

When the Environmental Protection Agency (EPA) rolled out its Clean Power Plan's ambitious decarbonization framework in 2015, S&P Global Ratings analysts associated operational and financial hurdles with the plan's targets, including the costs of revamping generation resources. Although the Trump administration supplanted the Clean Power Plan with the less-stringent Affordable Clean Energy Rule in 2018, this did not alter our view of the exposures carbon-based fuels present. We concluded that the specter of more stringent emission regulations remained. We based our conclusion on public sentiment favoring decarbonization and the influence of investors and other utility stakeholders who are increasingly exhorting utilities to align business strategies with a strengthening of ESG attributes. Within the ESG framework, the environmental effects of electricity production are a particularly prominent area of our focus because of the greenhouse gas emissions and solid byproducts that flow from electricity production.

Although a federal court judicially invalidated the Affordable Clean Energy Rule in January and remanded the rule to the EPA for further consideration, we believe the prospects for the EPA's revival of the rule's lighter approach to decarbonization relative to the Clean Power Plan are slim because the Affordable Clean Energy Rule does not align with prevailing public and political views. We believe the public, regulators, and legislators favor accelerating the pace at which utilities remediate noxious emissions. Further supporting this view are the flurry of President Biden's environmental executive orders and his nominees to posts that will provide environmental oversight. We believe the president's actions telegraph the significant weight the administration ascribes to environmental remediation.

Reversing Course And Taking Control

Some considered the Clean Power Plan's provisions to be so formidable that 24 of 50 states and many utilities and their trade associations sued the EPA to block the regulation. The plaintiff class included the National Rural Electric Cooperative Association, the American Public Power Association, and many cooperative utilities, including Basin Electric Power Cooperative and Tri-State Generation and Transmission Association. Some utilities viewed achieving compliance with the Clean Power Plan's decarbonization framework as such a daunting undertaking relative to their existing generation portfolios that they contemplated relying on provisions of the regulation that would allow some coal generation to continue to operate and to contribute modestly to U.S. electricity production. Management at these utilities assumed--possibly presumptuously--that it was their coal fleets that would count toward the acceptable levels of legacy coal contemplated by the Clean Power Plan. They assumed that their passive strategy would not be preempted by other utilities that planned to adopt a similar stance. Therefore, they faced the risk that other owners of coal generation could exhaust the coal allowance and frustrate their plans to rely on the limited carveout for coal.

Yet, within only a few years, we have seen a significant departure from the early posture of resisting more stringent emissions regulations. Utilities are shifting toward embracing decarbonization and away from resisting it. Although during the Trump administration the pressure to decarbonize was less immediate than it had been during the Obama administration, in 2020, management at several electric cooperative utilities opted to proactively define decarbonization glide paths, rather than wait for the government to impose decarbonization mandates. Among these utilities were some that only a few years earlier had joined the lawsuits to block the Clean Power Plan's implementation.

The electric cooperative utilities that have announced significant decarbonization goals include Colorado's Tri-State Generation and Transmission Association, Minnesota's Great River Energy, North Dakota's Basin Electric Power Cooperative, and Virginia's Old Dominion Electric Cooperative. In addition to embracing greater environmental stewardship, these utilities' decisions likely reflect recent years' poor economics of coal-fired generation relative to electric production using natural gas, wind, and solar resources. Utilities and the EIA report that relative economics diminished the dispatch of coal units in recent years to a greater extent than environmental beneficence (chart 3).

Chart 3

Great River Energy's electricity production from coal dropped to 58% in 2019 from 72% in 2015. In 2020, the utility announced its Phoenix Project that will retire almost 1,200 megawatts of coal-fired capacity at its Coal Creek Station by the end of 2022. The utility will also convert its Spiritwood Station to natural gas and add significant wind purchases. The utility projects that it will virtually eliminate coal-fired generation by 2025. Similarly, Tri-State Generation, which derived 56% of its 2019 electricity production from coal, compared with 59% in 2015, announced its Responsible Energy Plan in 2020. The plan will accelerate the retirement of coal capacity at the Craig Generating Station in Colorado and the Escalante station in New Mexico. Tri-State projects that by 2030, the utility will eliminate 100% of its Colorado and New Mexico coal-generation emissions. However, the utility will continue to source some electricity from the coal-fired Laramie River Station in Wyoming and Arizona's Springerville Unit 3. Tri-State projects that about half of its 2025 energy requirements and about one-quarter of its 2030 energy requirements will come from coal.

Although not as ambitious as the plans of Great River and Tri-State, Basin Electric targets reducing its electricity production from coal to 39% by 2025, a level we nevertheless consider high. However, it will be significantly lower than 2015's 70%. The utility has not announced targets for reducing coal's contributions beyond 2025, but management continues to explore opportunities for further reductions.

Great River Energy, Tri-State, and Basin all plan to add significant renewable resources to offset some of their coal-generation retirements.

Old Dominion Electric Cooperative's coal dependence is much more moderate than that of Tri-State and Great River. While in 2015, coal accounted for 45% of self-production and 20% of an energy supply portfolio that relied heavily on contract and market purchases, by 2019 market economics and Old Dominion's additions of gas resources reduced coal's contribution to a very modest 5% of the utility's overall power supply. Early in February, Old Dominion announced that by 2030 it plans to reduce its carbon intensity by 50% relative to 2005 levels and that by 2050, it is targeting achieving net zero carbon dioxide emissions.

For each of the utilities we have cited, we expect that their coal reductions will translate into not only lower environmental risks within the ESG framework, but also improve social risks because health and safety considerations reflect the benefits of utilities' removing pollutants affecting those living and working near power plants and their emissions. However, if decarbonization costs add rate-affordability pressures, we foresee the potential for greater social risks.

For Some Utilities, Barriers Remain To Environmental Stewardship And Improving ESG Profiles

The embrace of ambitious carbon and coal-reduction targets is not ubiquitous throughout the cooperative sector. We believe that some utilities and their customers lack the financial wherewithal to support decarbonization undertakings or that the scope of such initiatives would be too great for the utility's size. We view Kentucky's Big Rivers Electric Corp. and Southern Illinois Power Cooperative as utilities with these characteristics. Big Rivers' owned generation fleet is almost exclusively coal-fired, even after retiring a portion of its coal-fired generation fleet following load losses. Hydroelectric purchases from the Southeastern Power Administration and solar power purchase agreements moderately temper the utility's coal dependence. Coal accounted for a high 64% of 2019 electricity sales, down from 85% in 2015, as the utility took advantage of power purchase agreements and market purchases. In many respects, Southern Illinois Power's generation fleet and coal dependence mirror that of Big Rivers. Citing the October 2020 shuttering of its Marion 4 generation plant, Southern Illinois projects coal will account for a high 69% of 2021 generation, down from almost 100% in 2015 and 92% in 2020. Southern Illinois plans to look to market purchases and bilateral agreements to further reduce its coal dependence, but in the meantime its coal concentration continues to expose the utility and its customers to emissions-remediation costs.

Big Rivers benefits from a supportive regulator that approved the utility's creation of a regulatory asset for the recovery of the undepreciated investments in retired coal generation. We view rate affordability and the utility's modest size as limiting its ability to overhaul its generation fleet. However, the utility plans to add power purchase agreements for renewable resources to temper its carbon intensity. The service territories of both Big Rivers and Southern Illinois exhibit weak income indicators that we believe constrain financial and operational flexibility.

For utilities like Big Rivers and Southern Illinois, their overwhelmingly coal-fired generation assets and limited prospects for reinventing the utilities could constrain ratings. We believe the utilities' substantial coal dependencies contribute to environmental risks within the ESG framework. In addition, the potentially burdensome costs low-income consumers might bear as these utilities pursue compliance with evolving and more stringent emissions regulations weigh on the ESG social risks the utilities face because compliance costs could conflict with limits on ratemaking flexibility.

S&P Global Ratings will continue to evaluate utilities' transitions away from carbon-intensive fuels and how their transformations affect their ESG profiles.