Chart 1

Stable Consumption And Cost Recovery Drive Our Sector View

During the past decade, public power and electric cooperative utilities' megawatt-hour sales have remained within a narrow band. The limited variability within that band primarily reflects an amalgam of economic and weather factors (chart 2) and these not-for-profit utilities' contributions to national energy sales have been consistent, which aligns with the sectors' largely sound and stable ratings (chart 3). We view the essentiality of electric service to homes and businesses as tempering the effects of fluctuating economic and weather conditions.

Chart 2

Chart 3

Sector Top Trends In 2023

Against the backdrop of largely stable energy sales, financial performance, and ratings among public power and electric cooperative utilities, S&P Global Ratings analysts have identified latent risks facing electric utilities and their management teams. These exposures include inflationary pressures, the related potential for diminished ratemaking flexibility and increased customer payment delinquencies, the operational and cost effects of supply chain disruptions, the specter of financing compliance with more stringent emissions regulations, and increasing physical and cyber threats to utility networks.

Inflationary and recessionary pressures

Our economists project that the U.S. economy is likely to fall into a shallow recession in 2023, tempered by moderate initial jobless claims and unemployment rates (see "Economic Outlook Sees The U.S. Tipping Toward Recession," published Nov. 28, 2022, on RatingsDirect). Consequently, we continue to monitor the strength and stability of public power and electric cooperative utilities' revenues for evidence of delinquent payments or other revenue erosion because inflation (see chart 4) and higher interest rates are whittling consumers' discretionary income. Affordability of electricity is particularly significant because national electricity prices increased 14.3% for the 12 months ended December 2022, compared with a 6.5% increase in the consumer price index's broader basket for the same period.

Chart 4

In 2022, electric utilities faced significant increases in many costs, including fuel, labor, materials, and capital costs; we expect inflated prices to persist in 2023. Natural gas and coal continue to represent the leading fuels for electricity generation in the U.S. (chart 5) and purchases of these fuels are among utilities' largest expense components. The price of natural gas increased sharply in 2022 (chart 6) and, based on Energy Information Administration forecasts, we anticipate prices will remain at elevated levels into 2023.

Chart 5

Chart 6

We are watching to determine whether high electric bills in an inflationary environment that challenges affordability in myriad consumer spending categories create resistance to implementing the rate adjustments that we anticipate will be critical to maintaining sound financial metrics. Similarly, we will monitor whether high electricity prices become the catalyst for consumer payment delinquencies that might sap utilities' liquidity reserves. Potentially compounding this exposure is consumers' exhaustion of pandemic-related stimulus funds that we believe helped avert significant customer delinquencies during the peak of the COVID-19 pandemic.

Since natural gas is a key electricity production input, high natural gas prices are contributing significantly to elevated electricity prices. Although U.S. natural gas prices moderated in the second half of 2022, they nevertheless remain high relative to prices over the past decade reflecting increased reliance on natural gas for domestic electricity generation and intensified foreign demand for U.S. natural gas due to Russia's reduced gas deliveries. Together with natural gas, the price of coal mined in several U.S. basins increased significantly in 2022 as the conflict in Ukraine inflated international demand for U.S. coal.

In addition to fuel-related cost pressures, utilities are facing elevated interest rates when borrowing, higher labor costs, and elevated costs for materials that are critical to capital projects, operations, and maintenance.

Price pressures and electric rate affordability are also placing a greater emphasis on the role of utility liquidity. As utilities face higher and more variable operating and capital costs, liquidity reserves can provide an important bridge that insulates utilities from financial stresses pending rate increases to recover unexpected costs. Liquidity can also provide a cushion that can either forestall potentially unpalatable retail rate adjustments in a recessionary environment or help temper increases in delinquent customer payments.

The pace and cost of decarbonization

Although the U.S. electric industry eliminated nearly one-quarter of its carbon emissions over the past decade, the sector continues to exhibit a substantial reliance on carbon-based coal and natural gas (chart 5, above). We believe that transitioning to cleaner resources will entail substantial and costly replacements of much of today's generation fleet. Therefore, our analytics focus on assessing how well utilities can migrate from carbon-intensive thermal generation while maintaining operational reliability and affordability. We believe that actions that compromise reliability and increase the number of outages or calls for consumers to repeatedly curtail electricity usage during peak periods can lead to customer fatigue and trigger resistance to rate adjustments necessary for maintaining sound financial metrics. In our opinion, when customers perceive that the quality and reliability of the service their utility provides is not commensurate with the prices they are paying, they are more likely to oppose rate adjustments.

The federal government and many states have adopted or are pursuing decarbonization goals. We will continue to assess these regulatory and legislative initiatives to determine whether they will add costs that degrade financial performance or compromise operational performance.

The costs of premature power plant retirements

If the timing for retiring generation to achieve decarbonization initiatives materially precedes the end of the affected assets' useful lives, consumers are likely to shoulder either accelerated depreciation costs or an amortization of undepreciated costs that extends years beyond the retirement of the assets.

Over the long term, consumers could see more favorable electricity costs as renewable resources that exhibit nominal variable production costs displace generation using costlier conventional fuels. In the near term, however, the costs of constructing or contracting renewable resources and the costs of recovering investments in prematurely retired conventional thermal resources might strain rate affordability and ratemaking flexibility.

Expectations for more distant siting of generation

Because renewable technologies exhibit lower generation footprint densities than thermal generation, the outsize land requirements of these resources will likely lead to the siting of generation in locations that have large swaths of open land that are more remote from the load they serve than the resources they replace (chart 7).

Chart 7

Similarly, it is likely that storage devices needed to counter the intermittency of renewable resources will be distant from loads.

Supporting remote generation and storage will likely encumber utilities and their customers with the costs of amassing parcels of land to host these resources. Distance from load will also produce a need to develop or pay others to develop transmission to convey remote generation output to load.

Storage investments to counter the intermittency of renewable resources will also expose consumer bills to the skyrocketing costs of materials like nickel, cobalt, and lithium that are the backbone of the most prevalent battery technologies.

We expect that financial incentives of the Infrastructure Investment and Jobs Act and the Inflation Reduction Act will temper some of the transition costs for public power and electric cooperative utilities, which should help preserve electric utilities' financial metrics and ratings. However, the dollar value of these benefits to each utility remains uncertain pending regulatory clarifications.

Extreme weather and climate events

Weather events once considered rare are becoming more frequent and severe. The scope of weather and climate events that have and can adversely affect utility operations and revenue collections is broad and includes wildfires, droughts, hurricanes, and extreme temperatures.

We believe that strategic planning that helps avert outages attributable to weather events is critical because lengthy or frequent outages can lead to customer ire and resistance to rate adjustments.

Supply chain challenges

Supply chain disruptions affecting the utility sector commenced with the COVID-19 pandemic's business closures and have morphed into persistent structural problems that are an outgrowth of staffing shortages and obstacles to accessing critical supplies and materials. So far, these disruptions are having only moderate effects on operational reliability and costs at public power and electric cooperative utilities. Yet, supply chain disruptions can lead to more pronounced effects if they undermine electric service reliability or lead to higher rates.

Coal train blues.  Coal delivery disruptions are among the prominent supply chain issues facing electric utilities. Difficulties sourcing coal for power plants are an outgrowth of an amalgam of suboptimal railroad staffing levels, the wariness of financially challenged coal mining companies to invest in mine expansions or productivity enhancements that might be idled by more stringent environmental regulations, and the price and demand pressures European competition for U.S. coal are creating in the wake of Russia's military and economic actions.

To conserve coal inventories for peak winter and summer days when the need for coal-fired generation will be most pronounced, several coal-burning utilities report that they are periodically dispatching natural gas plants ahead of their coal plants during non-peak periods, even when coal dispatch would be more economical. Deviating from the traditional dispatch queue that ordinarily prioritizes generation dispatch based on the relative economics of each generation fuel adds to operating costs and retail rates, which could compromise financial flexibility, financial margins, and ratings.

Short-circuiting the transformer pipeline.  Another notable manifestation of supply chain issues in the power sector is the shortage of electric utility transformers across a broad spectrum of transformer sizes and voltages. Transformers are in short supply due to a dearth of domestic manufacturers, foreign and domestic manufacturers' difficulties in sourcing components for assembling transformers, and shipping bottlenecks that are delaying foreign deliveries. Consequently, multi-year waiting lists for transformer orders have become the norm and transformers are commanding exceptionally high prices.

The sector's limited inventory of spare transformers and the inability to expeditiously source new transformers can create a credit exposure because the shortages can frustrate utilities' incident recovery efforts and revenue rehabilitation if customers lose power due to physical attacks on the grid or extreme weather events that can damage existing transformer installations. In addition, difficulties in sourcing transformers can impede load growth within a utility's service territory if it is unable to serve new housing developments or businesses due to a lack of transformers. Barriers to load growth can frustrate the ability of a utility to more efficiently allocate fixed costs over a growing customer base.

Access to capital markets

The capital-intensive utility sector requires robust access to capital markets to finance and amortize the costs of generation, transmission, distribution, and ancillary assets across the life of the assets. Constructing and maintaining utility infrastructure is an expensive proposition and access to long-term capital is an essential vehicle for tempering the burdens consumers would otherwise bear if utilities were to need to recover capital costs when incurred. Access to long-term borrowing enables utilities to equitably distribute their capital expenditures along a continuum of consumers who benefit from the assets across the assets' life cycle. Therefore, access to long-term capital is an underpinning of credit quality because it facilitates rate affordability that promotes sound financial performance and access to the liquidity needed to respond to variable and sometimes unbudgeted operating costs.

Recently, some investment banks have announced that they may limit financing to utilities that produce electricity using fossil fuels whose emissions exceed prescribed thresholds. The thresholds vary from bank to bank. So far, public power and electric cooperative utilities report that they retain sufficient access to capital despite some banks' actions. However, if the list of lenders shying away from the power industry grows and compromises utilities' access to capital, the results could be consequential for ratings. Nevertheless, we do not expect capital markets to cross this threshold in 2023.

An uptick in cyber and physical security risks

After the February 2021 winter storm event in Texas, many areas were without power for more than a week. These blackouts provided a taste of the disruptions that bad actors might cause if they could shut down parts of the U.S. electric grid, whether through cyber or physical attacks. Either way, crippling the grid could have far-reaching implications beyond the financial health of electric utilities. If the grid is disabled, cities and commerce could come to a standstill. Consequently, these vulnerabilities make the seemingly endless supply of electricity that we take for granted an attractive target for malicious actors. Averting attacks on the grid requires vigilance on the part of utility management to preserve utilities' financial performance, commerce, health, and safety.

Rating Distribution

Chart 8

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