The risks of acute, extreme weather events for U.S. utilities are rising. Five of the country's worst natural disasters have all occurred since 2005, totaling $523 billion in inflation-adjusted damage. Another 22 major disasters, exceeding $1 billion, hit the U.S. in 2020--six more than the previous annual record, according to the National Oceanic and Atmospheric Administration (NOAA). What's more, the climate of the U.S. is changing, with the average temperature now at 54.4 degrees Fahrenheit--up 2.4 F above the 20th century average--and more and more variable rainfall. Annual rainfall was 76.9 cm (30.3 inches) in 2020, 0.86 cm (0.34 inches) greater than the long-term average through the same time period. However, these averages mask geographic differences over time: California has warmed by more than 3 degrees F over the same period, for example.

To withstand the increasingly extreme and variable climate, U.S. utility companies, which manage large and complex networks, are making massive investments to strengthen and upgrade assets. At the same time, they need to consider the needs of stakeholders, which include maintaining high standards of network reliability and customer service. Complicating matters, the physical assets of U.S. utilities are typically located with a defined service territory that includes homes and businesses built in riskier areas. To protect their assets as well as maintain security of supply, we believe U.S. utilities will benefit from a clearer understanding of acute and chronic physical climate risks—including from wildfires, water stress, hurricanes, and rainfall as well as sea level rise, temperature change, and rainfall patterns--and better foresight, using enhanced climate analytics, about when and where they will occur.

Extreme Weather Is Not A New Phenomenon For U.S. Utilities

While acute, extreme weather events are not new risks to utilities, they have become more frequent as the Earth's temperature continues to rise as a result of past and recent increases in global greenhouse gas (GHG) emissions. Extreme event attribution science--the research and modeling that seeks to attribute, or not, extreme weather events to human-caused climate change--shows that the majority (70% of 405 such events in the last 20 years) have been made worse or more likely by climate change (see Carbon Brief's attribution atlas, updated annually, for a useful summary). Indeed, particularly damaging events like Hurricane Harvey in 2017 appear to be on the increase. The Category 4 hurricane disrupted over 21 gigawatts of power generation assets in Houston, 6,200 poles and 850 transmission structures were damaged, and evacuations and shutdowns were put in place, as reported by McKinsey. More recently, Hurricane Ida, a strong Category 4 hurricane, caused power outages to over 1 million customers in southern Louisiana and knocked out all eight of the transmission lines that deliver electricity to New Orleans, leaving the city without power.

Storm-related flooding, wildfires, heat waves, and water stress tend to be the biggest hazards for U.S. utilities. Exposure to any of these climate hazards can disrupt operations, particularly since the sector relies heavily on asset output. On the other hand, U.S. utilities tend to be less exposed to cold waves. Still, severe winter weather can and has impaired utilities' operations, most notably the 2021 North American cold wave that gripped much of Texas earlier this year (see "Winter Storm In Texas Will Continue To Be Felt In Utilities’ Credit Profiles," published on March 15, 2021). Furthermore, integrated utility companies are also exposed to the risks of sea level rise, particularly where they have assets in coastal locations, such as power plants that rely on ample supplies of water for cooling or to drive steam turbines. The water-intensive nature of utility companies' operations also exposes companies to water scarcity, where droughts can lead to shutdowns or reduced output.

Our "ESG Evaluation Analytical Approach," Dec. 15, 2020, captures the sector and geographic exposure of entities to the physical impacts of climate change, as well as their exposure relative to peers.

Companies' Plans Will Need To Be Watertight

This year may offer a window into what the future may hold. Indeed, 2021 has seen record-breaking droughts affect the western half of the U.S, particularly California, Nevada, and Arizona. Simultaneously, central states were hit by severe heat waves. Record-breaking wildfires burned nearly 3 million acres during the first seven months of this year alone (nearly 1 million acres more than this time last year), according to NOAA.

Across the U.S., utility companies have reacted including:

• PG&E Corp. (BB-/Negative) in California;
• Portland General Electric Co. (BBB+/Stable), PacifiCorp (A/Stable), and Idaho Power Co. (BBB/Stable) in Oregon; and
• NV Energy Inc. (A/Stable) in Nevada.

These utilities have improved fire management and detection practices and have preemptively turned off power lines to avoid starting fires. In California, the state's grid operator asked its 39 million residents to ration electricity usage or face the prospect of power outages.

Climate projections produced as part of the Fourth National Climate Assessment suggest that all U.S. regions will be affected by climate change to some degree, with impacts varying by geographic location and time. While flood risk is projected to increase by the end of the century, particularly in the Northeast and Midwest, water stress and drought risk are expected to impact central states and the region of the Southern Great Plains. Average temperatures are projected to increase across the U.S.

Even though U.S. utilities have made progress in recent years, including a focus on sustainability reporting, they may not be sufficiently prepared for what the future may hold. A recent study by Webb et al. (2020), cautioned that most U.S. electric utilities do not undertake climate change risk and vulnerability assessments. Detailed studies like these serve to bring clarity to the changing frequency and severity of climate hazards, including wildfires, storms and droughts, and their impacts. Indeed, such assessments may help utilities plan for and build resilience to more extreme weather events and long-term climate change. Reasons for the utilities not undertaking such assessments included questions about the uncertainty surrounding different climate hazards, including the precise timing and crystallization of impacts, as well as a lack of data. (In a separate white paper, we explored some of the issues associated with data output from climate models and analytics; see "Model Behavior: How Enhanced Climate Risk Analytics Can Better Serve Financial Market Participants," June 24, 2021).

In addition to this evidence of insufficient preparedness by some, a recent report by ICF, a consulting firm, has suggested that U.S. utilities have in some cases been slow to respond to the threats posed by physical climate risks. This may leave companies exposed to a $500 billion resilience investment gap that could increase in the absence of concerted action. While this may be noteworthy as a point-in-time assessment, we note that capital expenditures are increasing across the sector and are now at or near record highs in a multiyear trend that reflects the proactive deployment of capital to modernize and improve utility generation and network assets (see chart 1).

Chart 1

Exposure To Physical Climate Risks Will Keep Driving Rating Actions

In most cases, acute risks prove manageable and are supported by recovery mechanisms to allow utilities to recuperate related costs. In the most extreme events, including those of late, utility companies' exposure to acute and chronic climate risks can damage assets or disrupt supplies, which can weaken their financial position and ultimately credit quality. For this reason, we seek to understand from utilities' management their prospective view of future climate-related risk and if they are taking sufficient action to mitigate their exposures.

Although we currently do not consider climate scenarios in the base case for our ratings on utilities, exposure to physical climate risks has already negatively affected credit ratings for U.S. investor-owned utilities. However, they can improve our understanding of rated utilities' potential exposures, preparedness, and the potential future influence of climate risks on credit quality over years and decades to come. In recent years, we have taken negative rating actions on several U.S. investor-owned utility companies, including reassessing the credit quality of California utilities exposed to devastating wildfire, exposure to coastal flooding from hurricanes, and the severe winter weather in Texas and Oklahoma in February 2021 that resulted in extraordinary natural gas price spikes. On the other hand, in some cases, we have taken a more favorable view of some companies' business risk profiles due to strong management of exposure to these hazards or to recognize climate-related growth opportunities. We list some of those rating actions in the appendix.

Utility companies are also highly exposed to transition risks, and many of them are proactively managing the transition by divesting from coal and shifting capital to focus on renewables. This move enables companies to keep up with strengthening and prospective environmental regulation, which has become more prevalent in recent years as countries make efforts to limit global warming to below 2 degrees Celsuis, in line with the Paris Agreement. Indeed, many companies have already started to sell or shutter their coal-fired generation and midstream natural gas assets to reduce their exposure to transition risks. Although we note the materiality of transition risks, we intentionally exclude them in our analysis, so as to concentrate attention on exposure to physical climate risks. (For a wider discussion of U.S. utilities' exposure to environmental, social, and governance risks, including those related to the transition to a low-carbon economy, see "How ESG Factors Are Shaping North American Regulated Investor-Owned Utilities’ Credit Quality,"April 28, 2021).

Scenario Analysis May Help Utilities Plan For An Uncertain Future

The use of climate projections is not new to utility companies, many of which already use the outputs from climate models as part of their risk management strategies, to inform strategic planning and investment decision-making. This is unsurprising, given utility companies are particularly exposed to physical climate risks, compared with companies in other sectors, as noted earlier. Furthermore, and more recently, climate risk management frameworks have been designed to help utility companies assess their exposures and to identify, and take advantage of, opportunities that climate change may bring (see McMahan and Gerlak, 2020). Application of such frameworks can help demonstrate to credit analysts a company's understanding of their exposure and may serve to evidence the presence of appropriate mitigating actions.

Despite improvements in climate science in recent years, particularly about the direction and magnitude of change of specific climate variables, climate models still hold uncertainties. In particular, it is impossible to predict with accuracy the precise timing or severity of the manifestation of both chronic and acute physical risks that could damage company assets. As such, considering a variety of scenarios and timepoints in forward-looking analyses enables us to understand utility companies' possible future exposures and enhance our dialogue when analyzing their creditworthiness.

It should be noted that the physical risk scores we refer to here do not consider adaptation measures that utilities have put in place to mitigate either current or future exposures to climate hazards. As such, existing and future adaptation measures may serve to reduce (or in some cases actually increase) exposure. For that reason, we believe that these scores should be complemented with dialogue from issuers to further understand physical risk exposure and what actions they have taken to reduce it.

While looking ahead over the next 30 years, our analysis also focuses on nearer timepoints (for example, 2030) where the scores may signal high physical risk for particular hazards. However, a certain amount of change is locked in due to the lag in the climate system owing to historic GHG emissions. Therefore, there is sometimes little difference between the RCPs and resulting physical risk scores for pre-2050 timepoints. Less emphasis should be placed on physical risk scores for pre-midcentury, given the effect of this lock-in and uncertainty in modeling some hazards, where climate scientists have greater certainty over the direction and magnitude of change in average temperature than, for example, wind. Clearly, this observation does not in any way reduce the risk of climate-related actions during the next decade. We remain focused on surveillance of these issues in our assessment of credit risk for all rated utilities.

Also note that in our analysis, exposure to hurricanes is taken as present day (that is, 2020) as reliable projections for this particular hazard are unavailable. Despite this, many scientists expect an increase in extreme wind speeds in the future over parts of Central and North America, and a poleward shift of storm tracks and associated changes in wind patterns.

High Wildfire Exposure On The West Coast Will Worsen, With Transmission Lines Concentrating Most Of The Risk

While 84% of wildfires recorded in the U.S. Forest Service's Fire Program Analysis-Fire Occurrence Database from 1992 to 2012 were started by human activity, increased temperatures have also contributed to drying vegetation leading to increased severity and duration of the West Coast wildfire season. Lengthening of the summer dry season is also a contributory factor, priming the region for larger fires. In recent years, wildfires--also a common natural phenomenon in California--have disrupted the operations of many West Coast U.S. utilities, including Sempra Energy (BBB+/Negative), Edison International (BBB/Stable), San Diego Gas & Electric Co. (SDG&E; BBB+/Stable) and PG&E (BB-/Negative). In the case of PG&E, in 2018 it admitted liability for causing wildfires due to faulty equipment, ultimately paying out $25.5 billion to resolve its fire-related liabilities. Other utilities, including Pacific Power and its parent PacifiCorp, are facing litigation related to wildfires in Oregon in 2020. In 2020, we revised our view about the North American regulated utility industry for investor-owned utilities to negative from stable, due to several factors including unprecedented wildfire activity during the record-breaking 2020 wildfire season (see the list of rating actions in the appendix). It is important to note that wildfire risk exposure is not the same as credit risk, which takes into account the important regulatory and legislative factors that vary from state to state and can determine a utilities' exposure to financial losses.

Our analysis reinforces the view that the greatest material exposure from wildfire is predominantly to utilities' transmission lines through 2050:

• About 19% are highly exposed under RCP8.5, scoring 70 or more on our 1-100 scale.
• About 17% are highly exposed under RCP2.6, scoring 70 or more on our 1-100 scale.

Exposure increases negligibly to 35 in 2050 under RCP8.5 from 34 if all transmission lines are included (rather than those highly exposed). Wildfire exposure remains broadly consistent under both high (RCP8.5) and low (RCP2.6) scenarios, and the timepoints (2030 and 2050) considered in our analysis.

Natural gas pipelines have similar levels of exposure to wildfire as transmission lines. However, these assets are usually undergrounded and, as such, wildfire is a less material risk. The next most-exposed assets to wildfire are power plants (33 out of 100 under a baseline scenario), with exposure negligibly increasing under an RCP8.5 high-stress scenario (34 out of 100) in 2050. In either case, exposure is moderate (scoring 30 to 69 on our 1-100 scale). Exposure negligibly decreases under an RCP2.6 low-stress scenario (33 out of 100) in 2050. About 16% of utilities' power plants are highly exposed to wildfire (scoring 70 or more out of 100) under an RCP8.5 high-stress scenario in 2050 (exposure is the same under a low-stress scenario in 2030).

The relationship between rising temperatures under climate change and fire extent, particularly in the U.S., has been known for some time. It is unsurprising then that the U.S. West Coast contains eight of the top 10 states with the highest average exposure to wildfire in 2050 under an RCP 8.5 high-stress scenario (see our commentary on the exposure of U.S. public finance to this hazard: "Better Data Can Highlight Climate Exposure: Focus On U.S. Public Finance," Aug. 24, 2020).

Of the 24 corporate U.S. utilities included in our analysis, and when we consider all asset types (except undergrounded natural gas pipelines that have limited wildfire exposure), Edison International, with large operations in California through its subsidiary Southern California Edison Co., has the highest unmitigated wildfire exposure scoring an average of 90 (on our 1-100 scale, where a score of 70 or greater is considered high), under both RCP8.5 high-stress and RCP2.6 low-stress scenarios in 2030 and 2050. Switching attention to the company's transmission lines only, Edison International continues to have the greatest unmitigated wildfire exposure under all scenarios and timepoints considered (see table 1).

The assets of Idacorp Inc. (BBB/Stable) (again, excluding natural gas pipelines) are also highly exposed to wildfire under a baseline (present-day) scenario (score 78 out of 100). We also score exposure 78 by 2030 under an RCP8.5 high-stress scenario. By 2050, under the same scenario, we anticipate unmitigated exposure to increase marginally to 81 out of 100, primarily due to an increase in exposure of the company's transmission lines in Wyoming. However, under RCP2.6 by 2050, we expect moderate exposure, albeit at the upper end (a score of 69 out of 100). Regarding assets (excluding natural gas pipelines) that are highly exposed to wildfire (scoring 70 or more on our 1-100 scale), 78% of Idacorp's assets are currently highly exposed under a baseline scenario without adaptation interventions. The proportion of assets highly exposed increases under an RCP8.5 high-stress scenario by 2050 to 82% (or 77% by 2030). Under an RCP2.6 low-stress scenario in 2050, we expect moderate exposure (55%) of the company's assets. Limiting the analysis to just Idacorp's transmission lines, the scores are similar suggesting that there is not one asset type significantly more or less exposed than another.

For PG&E, wildfire exposure across all asset types (excluding undergrounded natural gas pipelines) is moderate (score 54 out of 100) under a baseline, present-day scenario. Restricting the analysis to power plants only, exposure is high (82 out of 100) under a baseline scenario, with many power plants in northern California concentrating the risk absent adaptation. Under RCP8.5, we expect exposure to increase negligibly, though remain high (83 out of 100) by 2050 (or 81 in 2030) and to reduce by 2050 under RCP2.6 (72 out of 100). For highly exposed power plants only (those scoring 70 or more on our 1-100 scale), 74% of the company's power plants are highly exposed to wildfire under a baseline scenario in the absence of adaptation. The proportion of PG&E's power plants with high exposure increases to 77% by 2050 under RCP8.5 (or 74% under RCP2.6).

Although Trucost's physical risk data set suggests that PG&E's average wildfire exposure across all assets is moderate (scoring between 30-69 on our 1-100 scale), the company has been the cause of notable wildfire damage in the U.S. in recent years. That's because an average indicating moderate exposure can mask a single highly exposed asset, which can have high impact. Indeed, a faulty PG&E transmission line in Butte County, California, caused the 2018 Camp Fire.

Table 1 lists the top 10 rated utilities included in our analysis, ranked by highest to lowest in the fourth column, average exposure scores for all assets (excluding natural gas pipelines), as well as transmission lines only in 2030 and 2050, under baseline, RCP8.5 high-stress, and RCP2.6 low-stress scenarios.

Table 1

These findings demonstrate the importance of utilities' capital investments in adaptation measures that help to provide resilience to wildfire risk, enabling them to maintain high levels of customer service and reduce the likelihood of disruptions or shutdowns, as have been seen recently. Many companies are making or plan to make large investments to mitigate wildfire risk. For example, in 2019, both PG&E and Southern California Edison (a subsidiary of Edison International) committed to spend more than $1 billion on new transmission infrastructure. As part of this commitment, PG&E has developed a wildfire mitigation plan, which comprises system hardening, raising awareness by installing more weather stations throughout the company's service area, and more inspections and repairs to existing equipment. Other companies operating in the region have implemented similar plans, including Portland General Electric, which in June 2021 increased its vegetation management investments to more than $30 million annually, and SDG&E, which has invested about $2 billion in wildfire mitigation measures throughout its service territories since 2007.

Of the 24 utility companies included in our analysis, we expect Portland General Electric Co. to see the greatest increase in unmitigated wildfire exposure (increasing by 5 points to 43 under a high-stress scenario by 2050, or 38 by 2030 from 38 in the baseline scenario), with most of this increasing exposure concentrated on the company's transmission lines near Portland, Oregon. For comparison, the increase in exposure is negligible (rising 1 point) under an RCP2.6 low-stress scenario in 2050. The proportion of assets with high exposure to wildfire risk remains relatively muted, increasing to 11% by 2050 from 9% under the baseline scenario. Under a low-stress scenario, the proportion of highly exposed assets does not change from the baseline with 9% of assets highly exposed by 2050. Since transmission lines comprise the vast majority of the companies' assets in our database, there is little difference in asset exposure.

Avista Corp. also sees an increase in wildfire exposure by 2050 under an RCP8.5 high-stress scenario (increasing to 38 from 33). However, it's noteworthy that this overall exposure score, averaged across all asset types, is moderate (scoring between 30 to 69 on our 1-100 scale). Limiting the analysis to transmission lines only, there is little difference in exposure. We expect the increase in exposure to stem from the companies' transmission lines in Idaho.

It is worth reiterating that the causes of wildfires may be natural, for example, lightning or ignition of dry vegetation by the sun; or human, like unattended campfires. Many other factors contribute to the number of wildfires in an area in any given year, including how high summer temperatures are, how low precipitation is, and wind conditions. Research suggests a strong relationship between temperature and fire extent, particularly in the U.S., with warmer years generally having greater fire extent (principally due to fuel aridity) than relatively cooler ones, since the early 1980s. While the long-term change in climate that may increase the risk of wildfire events is relatively visible, it is not possible to precisely predict where and when specific wildfire events will happen and what damage they may cause. By their nature, wildfires (like heavy summer rainfall events in many parts of the world) are highly localized. Notwithstanding this, the potential increasing exposure over time highlights the importance of dialogue and learning about how companies consider these risks and whether they have measures in place to reduce wildfire risk.

Water Stress Is On The Rise In The U.S.

Utility companies can be highly exposed to water scarcity, and the materiality of this exposure is greater for water-intensive assets, like power plants, in the absence of appropriate adaptation measures. Of the 24 companies included in our analysis, Sempra Energy (BBB+/Negative) currently has the highest exposure to water stress (scoring 90 out of 100 when averaging scores across all power plants). This exposure is driven in part by the company's power plants located near San Diego, California. In 2050, under an RCP8.5 high-stress scenario, unmitigated exposure increases slightly (to 92) but remains high (in 2030 under the same scenario the score is 92 out of 100). Regarding highly exposed power plants (those scoring 70 or more on our 1-100 scale), 85% are highly exposed to water stress under a high-stress scenario in 2050 and 2030 (exposure does not change due to the high starting point). However, under the RCP2.6 low-stress scenario in 2050, this decreases to 80%.

Similarly, in the absence of adaptation measures, Xcel Energy Inc. (A-/Stable) is also highly exposed at present (receiving an average score of 71 out of 100 for its power plants) and remains the same under an RCP8.5 high-stress scenario by 2050. Focusing on just those power plants with high exposure (that is, those scoring 70 or more out of 100 on our 1-100 scale), 55% are highly exposed under a baseline (present-day) scenario, rising to 58% under RCP8.5 by 2050 (or 56% by 2030). Under the RCP2.6 low-stress scenario, exposure reduces to 56% by 2050. To help manage this exposure, Xcel has set a goal to reduce water consumption from power generation by 70% by 2030 (from 2005 levels). In addition, the company engages in regional and state water planning processes while also implementing water plans to forecast the company's water needs over the coming decades, which they expect will help to manage water stress risks.

Table 2 lists the top 10 rated utilities in our analysis, ranked by highest to lowest by the fourth column, average exposure scores for power plants only in 2030 and 2050 for baseline, RCP8.5 high-stress, and RCP2.6 low-stress scenarios.

Table 2

For companies with limited exposure to water stress risks in the baseline (present-day) scenario, significant changes in exposure could cause management challenges. Our analysis expects Fortis Inc. (A-/Stable) to see the greatest increase in unmitigated exposure of its power plants under an RCP8.5 high-stress scenario, although its power plants are already highly exposed at present (scoring 71 out of 100 at present), increasing negligibly to 74 by 2030 and remaining the same by 2050. Under RCP2.6, exposure increases by the same margin by 2050. The assets contributing most of the exposure are power plants located in Springerville, Arizona.

On the other hand, under an RCP8.5 high-stress scenario, some companies can expect to experience a decrease in water stress risks to their power plants. This includes Public Services Enterprise Group (PSEG), which we forecast could see decreased exposure of its power plants to water stress (scoring 57 out of 100 by 2050 under RCP8.5 from a baseline score of 65). This is mainly driven by a reduced exposure of the company's power plants located on the coast of New Jersey.

Other utility companies are also taking actions to mitigate their exposure to drought and water stress. For example, Duke Energy has an in-house Drought Mitigation Team tasked with monitoring water levels and implementing measures to reduce the risk of drought at exposed nuclear and coal-fired plants. Furthermore, Entergy considers water availability risks, such as changes to precipitation patterns through facility hardening, insurance, and water resource planning.

Hurricanes And Storms: The Biggest Credit Risks For U.S. Utilities Are Preparedness And Emergency Response

Hurricanes and storms can significantly interfere with utilities' operations. While the physical destruction from such storms can be catastrophic, the greatest risk from a credit standpoint is typically a perceived lack of preparedness and an ineffective storm response that can impair the relationship with regulators and customers. In 2020, tropical storm Isaias hit Connecticut, causing disruption that left hundreds of thousands of people without access to power for over a week. This event prompted the attorney general to investigate utility companies' accountability. As such, the Public Utilities Regulatory Authority imposed a civil penalty of $29 million on Eversource Energy (A-/Stable) for being unprepared to communicate with its customers during the storm, in addition to ineffectively implementing its town liaison program as the storm became critical. Furthermore, in 2019, PG&E's catastrophic emergency management account showed that storms had caused $205 million in damage to its distribution and generation facilities (among other assets). Increased costs due to direct damage and litigation may also eventually be borne by customers, especially when not covered by a company's insurance.

As noted earlier, exposure to hurricanes in our analysis is taken as present day (2020) because reliable projections for this hazard are unavailable. We found that NextEra Energy Inc. is the most exposed utility (average score of 56 out of 100), although moderately, to unmitigated hurricane risk when considering all company assets in highly exposed U.S. states. We consider highly exposed states to include: Texas, Louisiana, Mississippi, Alabama, Florida, Georgia, South Carolina, North Carolina, South Carolina, Virginia, Maryland, Delaware, New Jersey, New York, Connecticut, Rhode Island, and Massachusetts. However, 43% of NextEra's assets located in states with high exposure to hurricanes are also highly exposed (that is, scoring 70 or greater out of 100 on our 1-100 scale) to hurricane risk, without suitable adaptation measures. This exposure is primarily due to the company's footprint in Florida through its utility subsidiary Florida Power & Light Co., where hurricanes are commonplace. Limiting the analysis to transmission lines only, NextEra's hurricane exposure is almost identical with an average score of 56 out of 100; 45% of the company's transmission lines are highly exposed (that is, with a score of 70 or greater on our 1-100 scale). For power plants only, exposure is lower but still moderate (scoring 32 out of 100, while 23% of the company's assets were highly exposed (scoring over 70 on our 1-100 scale). Despite this inherent exposure within its service territory, our credit ratings on NextEra have not been adversely affected because the company, over the past decades, has proactively invested in system hardening, significantly reducing outages and restoration times. NextEra, through these initiatives, has reduced operating risk and demonstrated effective preparedness.

In line with 2019 Florida law, the company filed a long-term Storm Protection Plan, which aims to provide details about the company's plan to build a more storm-resilient grid. As part of this process, the company will conduct hardening of at-risk transmission lines and distribution facilities, in some cases rerouting distribution lines underground. We expect undergrounding lines will increase the company's resilience to hurricane risk, helping to provide customers with a reliable energy supply. This is evidenced by the fact that during Hurricane Irma (2017), 82% of the company's nonhardened main powerlines experienced outages, compared with just 19% of underground main lines. Furthermore, the company leverages scenario analysis using the best available climate projections, which we expect will support long-term asset resilience (see "ESG Evaluation: NextEra Energy Inc.," published on April 6, 2021.)

To put NextEra's relatively high (unmitigated) exposure to hurricanes into perspective, Duke Energy Corp. (BBB+/Stable) ranks second in our analysis with low exposure (scoring 16 out of 100 or 5% of all assets) under the baseline scenario. Note, this analysis is intentionally focused on U.S. states with high historical hurricane exposure.

Table 3 lists the top 10 utilities in our analysis ranked by highest to lowest average exposure scores across all assets and power plants and transmission lines, under a baseline scenario in highly exposed U.S. states only. Chart 4 presents the exposure of U.S. utility companies to hurricane risk under a baseline scenario, in highly exposed U.S. states only.

Table 3

Chart 4

Typically, utilities are well-placed to recover storm costs through various regulatory mechanisms. Even with a small proportion of assets highly exposed to hurricanes, utility companies still experience tail risk and can face large cost outlays when those highly exposed assets are impacted, particularly when such assets are highly productive. According to Trucost's dataset, 3% of Entergy Corp.'s (BBB+/Stable) assets in highly exposed states (and 3% of the company's power plants and transmission lines) are significantly exposed to hurricanes. Indeed, the company has incurred significant costs following recent storms. For example, the cost of restoring power following hurricanes Katrina and Rita in 2005 amounted to $966 million, the most significant damage to its distribution systems from storms in its history. Following Hurricane Katrina in 2005, it took 42 days to restore power to customers and more than 13,000 people were involved in the recovery process. Although the company did sustain system damage, a hardening study carried out in 2007 showed that 99% of its structures located within 20 miles of the Louisiana and Texas coastlines actually survived the hurricane's winds. Furthermore, following these events, Entergy created a $75 million storm reserve fund to restore electricity services to customers as soon as possible should similar events occur in the future.

Lastly, in the most extreme cases of coastal flooding, management teams may be confronted with unmanageable near-term business challenges. The decision by Entergy to file its utility subsidiary Entergy New Orleans LLC into Chapter 11 Bankruptcy Protection in 2005 illustrates the point very well, particularly in the scenario where a concentrated and vulnerable service territory became inundated from severe coastal flooding.

Sea Level Rise Represents A Long-Term Risk To Utilities, Flood Risk Is Generally Low

On average, the utility companies that we have studied here have low exposure to sea level rise, with most company assets located predominantly inland, except for conventional power plants that require water for cooling. That being said, we expect Entergy's exposure to sea level rise to increase the most (rising to 16 by 2050 under RCP8.5 from a score of 6 out of 100 in the baseline scenario) but remain low. Switching attention to assets that are highly exposed, 3% of Entergy's assets are highly exposed (that is, with a score of 70 of greater on our 1-100 scale) under a baseline (present-day) scenario, rising to 15% under an RCP8.5 high-stress scenario. Under an RC2.6 low stress scenario in 2050, exposure declines (11 out of 100) and 10% of the company's assets are highly exposed (those scoring 70 or more).

For Entergy, exposure comes primarily from transmission lines located near the coast in Louisiana, as well as eight company-owned power plants that are the property of subsidiaries Entergy Louisiana LLC and Entergy New Orleans LLC. Entergy also recognizes that rising sea levels and the loss of coastal wetlands will make their assets more exposed to storm impacts over time. The company has carried out climate scenario analysis, including for sea level rise, to determine potential exposures. To mitigate this exposure to sea level rise, the company has made investments in restoration projects for Louisiana's barrier islands and coastal wetlands. Other utility companies are also preparing for the impacts of sea level rise. For example, PG&E is conducting research on how to protect its assets, including investigating the feasibility of either elevating or replacing some of them. They estimate that moving and rebuilding a single substation could cost at least $100 million.

Change in exposure to sea level rise between the baseline (2020) and 2030 is relatively muted for all companies in our analysis because we generally expect exposure to this hazard to manifest over longer time periods. Although Entergy's increasing exposure, under the scenarios we consider, is the greatest increase that we expect to see, Public Service Enterprise Group Inc. (PSEG; BBB+/Stable) also may experience a relatively large increase in exposure to this hazard. The company's exposure across power plants increases 15 points (from 7 under the baseline scenario) to 22 out of 100 by 2050 under an RCP8.5 high-stress scenario, although it is important to note that exposure remains relatively low according to our scale. Under RCP2.6 by 2050, exposure to sea level rise is more muted (6 out of 100 on our 1-100 scale). The percentage of power plants highly exposed (scoring 70 or greater) to sea level rise is at its highest under a baseline scenario (2%), increasing to 22% of assets by 2050 under RCP8.5 (or 9% under RCP2.6 by 2050). Power plants located in low-lying areas near the coast in New Jersey concentrate most of the increasing (unmitigated) exposure.

The companies we consider in this analysis also have low unmitigated exposure to river (or fluvial) flooding under all timeframes (baseline, 2030, and 2050) and under both RCP8.5 and RCP2.6, high-stress and low-stress scenarios. Despite this, surface water flooding (also known as pluvial flooding) caused by heavy rainfall that typically follows storm events is often more disruptive than river flooding. However, replicating such highly localized events is a challenge in existing (global-scale) climate models and is therefore excluded from our analysis. That said, the resilience of investor-owned utilities to both types of flood risk has markedly improved in the last few decades due to adaptation investments. For example, Entergy Corp. (BBB+/Stable) has invested in raising vulnerable substations, in addition to building flood prevention measures for all of its new substations. Meanwhile, PSEG has replaced about 240 miles of low-pressure cast-iron mains from highly exposed flood risk areas, which is expected to reduce the likelihood of customers losing gas supply during flood events. Furthermore, PSEG has invested in elevating its Wing Township substation, which assisted in protecting the asset during Storm Alberto in May 2018.

Heat Waves And Cold Waves Are Muted

An increase in the frequency and severity of heat wave events is likely to result in increased financial costs for utility companies, with equipment failure leading to increased stress on transmission systems. For example, in July 2006, PG&E incurred costs of $150 million-$300 million resulting from increased prices of electricity and infrastructure repairs following heat waves in their service territories. More frequent and, crucially, longer heat waves restrict the time available for critical equipment, like transformers and cables, to cool down overnight, meaning that additional cooling equipment may be needed or upgraded to cope with higher future temperatures.

The 24 companies in our analysis generally have relatively low exposure to heat waves (scoring between 1 and 29 on our 1-100 scale when averaged across all assets). NextEra is the most exposed to this hazard in the absence of adaptation measures, although exposure also remains low (21 out of 100 under the baseline scenario). Exposure increases to become moderate in 2050 under an RCP8.5 high-stress scenario (45 out of 100). By 2030, heat wave exposure still remains muted (29 out of 100).

We expect that all companies will experience large increases in heat wave exposure over the next 30 years and beyond. In our analysis, NextEra is set to experience the greatest increase in asset exposure to this hazard. Indeed, even under an RCP2.6 low-stress scenario, exposure is expected to increase (to 29 out of 100) by 2050. To put this in perspective, the smallest increase in exposure to heat waves in our analysis comes from Portland General Electric, where we expect that exposure will more than double (reaching a score of 21 out of 100 on our 1-100 scale), but remain low, under an RCP8.5 high-stress scenario by 2050 from a score of 10 out of 100 in the baseline (present-day) scenario.

The only company with assets moderately or highly exposed (that is, receiving a score of 70 or greater on our 1-100 scale) to heat wave is NextEra under the baseline scenario. NextEra has 8% of assets moderately exposed (that is, scoring from 30-69 on our 1-100 scale). Under an RCP8.5 high-stress scenario in 2050, we expect over three-quarters (76%) of NextEra's assets could be either moderately or highly exposed to heat waves, more so as such hazards are forecast to become increasingly prevalent in Florida with climate change. We also expect to see the proportion of assets owned by Duke Energy that are highly exposed under an RCP8.5 high-stress scenario by 2050 to increase significantly to 58% from zero under a baseline scenario, in the absence of adaptation. Entergy also sees a large rise in the proportion of its assets that are highly exposed, increasing from zero in a baseline (present-day) scenario to over half (51%) of the company's assets under an RCP8.5 high-stress scenario, by 2050.

On the other hand, companies' exposure (averaged across all assets) to cold wave events is generally expected to reduce with time, particularly under an RCP8.5 high-stress scenario by 2050 where warming is greatest. All of the 24 companies included in our analysis have 100% of assets moderately exposed to cold wave (scoring between 30 and 69 on our 1-100 scale) under a baseline (present-day) scenario. This reduces to less than 10% of assets moderately exposed for all companies, with the exception of Avista (96% of the company's assets are moderately exposed by 2050 under RCP8.5, with an average score across all assets of 34 out of 100), with transmission lines in Montana expected to remain the company's most exposed assets in the absence of adaptation, and Portland General Electric Co. (70% of assets its assets are moderately exposed, with an average score of 32 out of 100), whose transmission lines in Oregon remain those most exposed to cold wave.

While scientists expect winter temperatures to generally warm (and to do so faster than summers), severe cold events like the North American cold wave that struck in February 2021 may increase in frequency and severity. The focus on winterization of utilities' assets has therefore been swift, and many companies have moved to harden their assets and build redundancy into their systems. In the case of the Texas blackouts experienced earlier this year, we lowered the ratings on two gas utilities and revised the outlooks for several other rated utility issuers (see the list of rating actions in the appendix).

Lowering exposure to cold waves may reduce utilities' operational costs and disruption related to snow, ice, and severe frost events in affected territories. Less use of heating, ventilation, and air conditioning (HVAC) in winter may also correspond to reductions in GHG emissions. However, it is unclear if increased use of HVAC systems in summer months may offset any benefits (including increased GHG emissions) gained through warmer winter temperatures. We do not factor these opportunities into our ratings given the uncertainties, including about the materiality, precise timing, and geographic areas that may benefit from the manifestation of opportunities that could emerge due to climate change.

How Data Can Enhance Transparency Of Physical Climate Risks For Investor-Owned Utilities

As the impacts from climate change become more evident with each passing year, S&P Global Ratings believes that increased transparency and reporting by the companies we rate about physical climate risks will become more and more important to credit quality. The ever-increasing investor demands for information about environmental risks is a positive development for credit research, but transparency by the companies we rate about longer-term physical risks and scenario analysis still has a long way to go before it begins to influence investment and credit decisions. That said, data, like the Trucost data for this study, can begin to shape conversations on adaptation strategies and preparedness. We believe most utilities we rate are well aware of these challenges, and they are adapting strategies and investments to better position themselves for a future that is likely to feature more pressure from the physical risk factors outlined in this paper. We need to look no further than the expanding capital spending budgets of regulated utilities (nearly a 10% compound annual growth rate over the past decade) to understand that key priorities are system upgrades, weather-related hardening, and managing the transition of vulnerable generation assets.

While progress has been made to improve the resilience of U.S. utilities to the physical impacts of climate change, more work is needed. Building resilience requires massive investments, both via operating costs and capital investments, with repayment often delayed by several years or decades. The pressure from these expenditures is already contributing to credit deterioration in the sector, and some management teams may find it difficult to achieve all of their priorities while maintaining credit quality. The long design lifetimes, fixed locations, and designs informed by historic weather events, serves only to increase the vulnerability of utilities' assets and the pace and scale of investment required. In the first instance, to gain a better understanding of the most material risks, climate risk and vulnerability assessments should apply to the entire value chain, extending beyond core assets like power plants, to transmission and distribution systems, among others.

At the same time, utility companies require better data to help inform business continuity management processes and risk assessments. Enhanced climate risk analytics can help provide greater transparency for market participants to identify and analyze potential longer-term risks and facilitate a dialogue with rated entities that are potentially exposed. Increased transparency surrounding these risks also presents an opportunity for issuers to demonstrate the benefits of existing or planned adaptations.

This exploratory physical climate risk analysis, which is cognizant of the inherent natural uncertainties associated with climate science, has the potential to provide greater insight regarding rated U.S. utilities' potential exposure to physical climate risks and how companies have adapted or plan to adapt to current and future climate physical risk.

Editors: Rose Marie Burke, Daniela Stauble. Digital Designer: Tom Lowenstein.

Related Research And Criteria

S&P Global Ratings research

• Utilities Are Spinning Off Their Midstream Assets To Support Credit Quality, Aug. 4, 2021
• Model Behavior: How Enhanced Climate Risk Analytics Can Better Serve Financial Market Participants, June 24, 2021
• How Are California’s Wildfire Risks Affecting Utility Credit Quality? June 3, 2021
• How ESG Factors Are Shaping North American Regulated Investor-Owned Utilities’ Credit Quality, April 28, 2021
• ESG Evaluation: NextEra Energy Inc., April 7, 2021
• Winter Storm In Texas Will Continue To Be Felt In Utilities’ Credit Profiles, March 15, 2021
• Damage Limitation: Using Enhanced Physical Climate Risk Analytics In The U.S. CMBS Sector, Feb. 19, 2021
• Scenario Analysis Shines A Light On Climate Exposure: Focus On Major Airports, Nov. 5, 2020
• PG&E Corp. And Subsidiary Outlooks Revised To Negative On Adverse Wildfire Conditions, Sept. 16, 2020
• Better Data Can Highlight Climate Exposure: Focus On U.S. Public Finance, Aug. 24, 2020
• Through The ESG Lens 2.0: A Deeper Dive Into U.S. Public Finance Credit Factors, April 28, 2020
• U.S. Municipal Sustainable Debt and Resilience 2020 Outlook: Sprouting More Leaves, March 4, 2020
• Space, The Next Frontier: Spatial Finance And Environmental Sustainability, Jan. 22, 2020
• The Role Of Environmental, Social, And Governance Credit Factors In Our Ratings Analysis, Sept. 12, 2019
• For Water Utilities, ESG Is Just Business As Usual, Dec. 12, 2018
• Can U.S. Utilities Weather The Storm? Nov. 8, 2018

Other research

• Understanding Climate Risks At The Asset Level: The Interplay Of Transition And Physical Risks, Trucost, Nov. 25, 2019

Appendix

Table A1

Rating Actions Due Exposure To Physical Climate Risks, Including Wildfires, Storms, And Hurricanes

• Edison International And Subsidiary Outlooks Revised To Negative On Adverse Wildfire Conditions; ‘BBB’ Ratings Affirmed, Sept. 16, 2020
• PG&E Corp. And Subsidiary Outlooks Revised To Negative On Adverse Wildfire Conditions; ‘BB-’ Ratings Affirmed, Sept. 16, 2020
• San Diego Gas & Electric Co. Outlook Revised To Negative On Adverse Wildfire Conditions; ‘BBB+’ Rating Affirmed, Sept. 16, 2020
• Sempra Energy Unsecured Debt Rating Lowered To ‘BBB’; Outlook On Subsidiary SDG&E Revised To Stable, May 13, 2021
• Atmos Energy Corp. Downgraded To ‘A-’ On Weakening Credit Metrics; Ratings Placed On CreditWatch Negative, Feb. 22, 2021
• OGE Energy Corp. And Sub. OG&E Outlooks Revised To Negative On Unprecedented Winter Related Costs; Ratings Affirmed, March 3, 2021
• ONE Gas Inc. Downgraded To ‘BBB+’ From ‘A’ On Unprecedented Weather Conditions; Outlook Negative, Feb. 23, 2021
• Entergy New Orleans LLC Downgraded To ‘BBB’ From ‘BBB+’ On Storm Risks, Outlook Negative, Oct. 8, 2020
• Caribbean Utilities Co. Ltd. Ratings Downgrade to “BBB+”, Outlook Stable, Oct. 21, 2019

(This list is not exhaustive.)