What's Behind Our Sector View?

Our 2024 expectations reflect our view of diminished ratemaking flexibility.  National retail electric rates increased sharply in recent years amid elevated operating, capital, and, more recently, borrowing costs, all of which have contributed to reduced affordability. The Bureau of Labor Statistics reports that average national retail electricity prices rose 18% in 2022 across all electric utility ownership classes. This average far eclipses June 2022's peak Consumer Price Index (CPI) increase of 9.1% and the year's 6.5% CPI increase.

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The burgeoning trend of diminished affordability correlates with weakening financial metrics at some public power and electric cooperative utilities and increases in delinquent and uncollectible accounts. These developments are the underpinnings of our 2024 outlook for the not-for-profit power sector.

Although the national rate of inflation continues to moderate, retail electricity prices remain elevated after outpacing increases in the CPI's broad basket of goods and services in 2022. We expect regulatory and legislative decarbonization investment directives will exert additional upward pressure on retail electric rates in 2024 on top of recent years' significant increases.

Where utilities' retail rate increases do not keep pace with rising costs due to customer affordability considerations, financial metrics and lender protections can weaken and ratings can be at risk.

High retail electric rates coincide with a litany of lofty prices for a host of goods and services, and there are many indications that consumers' wallets are straining. We view increasing delinquency rates among auto loans, consumer loans, and credit cards as indicators of consumers' finite capacity to pay high electric bills (see "Auto Lenders Face Headwinds From High Rates And Economic Challenges," published Oct. 18, 2023; "Global Credit Outlook: New Risks, New Playbook," published Dec. 4, 2023; and "Economic Outlook U.S. Q1 2024: Cooling Off But Not Breaking," published Nov. 27, 2023).

When rate-setting bodies yield to consumer resistance to rate increases, it can frustrate utilities' cost recovery and adversely affect credit quality. Historically, we viewed autonomous ratemaking authority as fundamental to stable credit ratings. More recently, we see instances of weakening fixed-charge coverage and liquidity and elevated delinquent and uncollectible accounts as diminishing the primacy of autonomous ratemaking as a rating consideration.

In 2023, we lowered the ratings on nine not-for-profit utilities. We also assigned negative outlooks to nine utilities. We assigned three of the nine negative outlooks simultaneous with the downgrade of the utility. These actions largely reflected a weaker alignment among revenues, expenses, and debt service where retail rates did not keep pace with rising costs.

Several factors magnify inflationary pressures. We view substantial portions of energy transition spending as nondiscretionary because the spending will be integral to achieving compliance with decarbonization mandates. Also, as utilities pursue generation additions and related capital projects in support of the energy transition and load growth, they and their customers will face the added burden of higher interest rates that are an outgrowth of the Federal Reserve's monetary tightening.

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Because consumers are depleting stimulus dollars received during the pandemic along with savings accumulated during those years, the constraints on ratemaking could increase (see "2023: Performance Beats Expectations And 2024: Resiliency Will Be Tested," published Dec. 13, 2023).

Natural gas is the leading electric generation fuel in the U.S. The Energy Information Administration projects moderate 2024 natural gas prices, which can help temper inflationary pressures and high costs for labor, materials, and borrowings. However, national average electricity prices have not retreated with gas prices, indicating that increasing operating, capital, and borrowing costs outpaced natural gas price declines.

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The effects of inflation on financial performance are apparent beyond those utilities with ratings and outlooks we took negative actions on in 2023. We affirmed ratings on some not-for-profit utilities that reported meaningful undercollections of unbudgeted 2022 operating costs or elevated delinquent and uncollectible accounts. The rating affirmations reflected fixed-charge coverage and liquidity metrics that were sufficiently robust to absorb portions of unbudgeted costs without eroding credit quality.

In coming months, public power and electric cooperative utilities will publish their 2023 financial statements. With those financial statements in hand, we will assess whether the resilience we associated with utilities whose ratings we affirmed in 2022 was sustained in 2023.

The burden of energy transition costs can strain utilities' financial performance.  We anticipate the onus of decarbonization costs could be substantial for utilities and their customers. For example, the Los Angeles Department of Water and Power (LADWP), which already sources more than half of its electricity sales from clean resources, published a long-term resource plan that projects adding $60 billion of capital expenditures, power purchase agreements, debt service, and variable costs, in support of achieving its goal of full reliance on clean energy resources by 2035. Therefore, the decarbonization plan will require significant multiyear rate increases.

Extrapolating from this utility's projected decarbonization spending provides insight into the magnitude of decarbonization costs that other not-for-profit utilities and their ratepayers across the country might face. On a proportional basis, costs reflective of utility size might be even more burdensome for the many utilities that depend on fossil fuels to a greater extent than LADWP. This energy transition spending benchmark underscores S&P Global Ratings' focus on affordability, its potential to frustrate cost recovery, exposures lenders face, and risks to ratings.

While we expect the federal Infrastructure Investment and Jobs Act (IIJA) and the Inflation Reduction Act (IRA) will fund meaningful portions of decarbonization costs, utilities report that they remain unable to specify the amount of financial support they will derive from these federal laws. In addition, we believe that the effects of inflation on the costs of decarbonization projects will consume some of the capped financial benefits available under the IIJA and IRA. If so, utilities and their customers could be saddled with substantial energy transition costs that transcend available IIJA and IRA funds as utilities invest to comply with legislative and regulatory mandates. We could lower ratings where utilities are unable to fully recover from customers energy transition costs not covered by the IIJA and IRA, at levels corresponding to existing ratings.

Electrification directives in support of decarbonization and load growth will add to generation spending.  The North American Electric Reliability Corporation's (NERC) December 2023 "Long-Term Reliability Assessment" foresees 10-year growth in peak electricity demand and megawatt-hour sales that will be "higher than at any point in the past decade."

Among the drivers of growing electric demand, NERC cites federal and state electrification mandates that require replacing cars and appliances fueled with natural gas, gasoline, and oil, with electric vehicles, electric appliances, and electric heating systems. NERC also cites the proliferation of energy-hungry data centers. In addition, the NERC report identifies a need to invest in dispatchable generation that is capable of countering the intermittency of clean, renewable resources.

It remains uncertain whether increased electricity sales flowing from electrification mandates will be at levels that enable utilities to economically allocate among their customers the additional fixed costs to fund generation needed to meet new load. If not, investments supporting electrification mandates can negatively influence the affordability equation.

NERC's report cautions regulators and policymakers to consider whether the timeframes they're establishing for meeting decarbonization and electrification standards are reasonable. It warns that the ambitious energy transition milestones could impair the reliability of the national electric grid. S&P Global Ratings views actions that destabilize electric service as a catalyst for consumer dissatisfaction and resistance to rate increases.

In addition to assessing energy transition costs, our analyses include a focus on the effects of migrating from carbon-intensive thermal generation to largely intermittent clean energy resources and the consequences of operational reliability and affordability. If the intermittent nature of clean resources, such as wind and solar, compromises reliability and increases outages, customers might perceive that the quality of utility service is not in proportion with the rates they're paying. Also, repeated calls for consumers to curtail electricity usage during peak periods, as has happened in California, Texas, and other states, can lead to customer fatigue and opposition to rate increases. Opposition to rate adjustments needed to support financial performance can negatively affect ratings.

Sector Top Trends

The energy transition will likely pressure electric rates and financial performance, as utilities remake generation fleets.  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 to intermediate term, however, the costs of constructing or contracting clean generation resources and the costs of recovering investments in prematurely retired conventional thermal resources might strain rate affordability and ratemaking flexibility because of the prevailing elevated costs for labor, construction materials, and borrowing.

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Extreme weather events and associated physical risks add to operational and financial exposures.  Frequent and severe hurricanes, wildfires, winter and summer temperatures, and other natural disasters, are an outgrowth of climate change. In addition to assessing utilities' capacity to recover costs related to the infrastructure damage climate events cause, our credit analyses also evaluate the costs of mitigating and possibly averting damage from increasingly severe climate events. The costs of investments that protect utility infrastructure and shield community residents and property from harm could reduce rate affordability and hinder financial performance and ratings.

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We view physical climate risks as a particularly acute exposure for electric utilities because, by their very nature, electric utilities rely on a portfolio of vulnerable infrastructure that is exposed to the elements, including miles upon miles of overhead transmission and distribution lines, substations, and power stations. Yet, the ability to mitigate exposure to extreme weather events might be constrained by diminished ratemaking flexibility. Although this is not quite a zero-sum equation, we believe utilities are limited in the amounts they can simultaneously spend on responding to energy transition directives and reducing exposures to physical climate risks. Allocating resources to energy transition mandates might come at the expense of system hardening against climate events or vice versa.

Reduced availability of insurance coverage and changeable support for governmental indemnification represent contingent demands on liquidity and financing needs.  In states like California, Florida, and Texas, which are particularly susceptible to extreme and damaging weather events, power utilities' access to insurance coverage has diminished or, where available, can only be procured at great cost. Moreover, public-sector disaster relief agencies, such as the U.S. Federal Emergency Management Agency (FEMA) and state agencies performing similar functions, periodically come under political pressure to reduce the availability of the financial relief they provide for storm recovery. Therefore, absent substantial liquidity reserves, an inability to secure adequate private property and liability insurance or legislative or regulatory actions that curtail reimbursements from FEMA and state agencies could increase the exposure of utilities to the financial burdens of acute events and impair credit quality.

The specter of cyber and physical attacks is another potentially costly exposure for the utility sector.  The disruptions that malicious actors might cause if they shut down parts of the U.S. electric grid, whether through cyber or physical attacks, 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 consumers take for granted an attractive target for malicious actors. Averting attacks on the grid requires vigilance and expenditures on the part of utility management to preserve operational reliability, financial performance, and the associated dependencies of commerce, health, and safety.

Key to resilience is developing robust cyber security and physical security protocols. Utilities lacking well-honed protocols, such as active detection and swift remediation, are the most vulnerable. We believe the proliferation of global conflicts heightens utilities' exposure to attacks.

Many not-for-profit utilities will continue to perform at current rating levels.  Despite the credit erosion some utilities manifest, and our view of the potential for contagion in 2024, the bulk of the sector continues to exhibit rating resilience with 93% of the not-for-profit electric utilities we rate assigned stable outlooks--and sector ratings are concentrated in the 'A' rating category. This rating and outlook distribution reflects our view that most public power and electric cooperative utilities exhibit financial metrics that provide sufficient headroom for absorbing elevated and mandated costs. Ultimately, the interplay among the reasonableness of the timelines for implementing energy transition directives, the costs of investments in infrastructure to support load growth, the affordability of retail rates, and management actions that are responsive to these developments, will determine the resilience of public power and electric cooperative utilities ratings.

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We also believe the essentiality of electric service will continue to contribute to financial stability in 2024. Historical data demonstrate the stability of electric sales volumes across economic cycles, but whether utilities will consistently be able to perpetuate stable electricity sales volumes at prices that preserve the alignment of revenues, expenses, and debt service and support existing ratings remains an open question.

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Lastly, we continue to view autonomous ratemaking authority as a cornerstone of the ratings we assign to public power and electric cooperative utilities. Although some utilities display diminished capacity to raise rates, they are not foregoing or limiting rate increases to a degree that exposes the sector to material nonpayment risk. Therefore, we believe autonomous ratemaking authority remains an important tool for balancing lender and ratepayer interests.

Related Research

• U.S. Not-For-Profit Retail Electric Sector Update And Medians: Despite Some Deterioration, Resilient Metrics Support Ratings, Dec. 13, 2023
• U.S. Not-For-Profit Natural Gas Utilities Medians Remained Stable In 2022 Amid Substantial Rise In Natural Gas Costs, Nov. 9, 2023
• Sustainability Insights: Managing Renewables Risk Is Increasingly Integral To U.S. Power Utilities Credit Quality, Oct. 9, 2023
• Cyber Risk Insights: Ongoing Preparedness Is Key To U.S. Power Utilities Keeping Attackers In The Dark, May 11, 2023
• Not-For-Profit Utilities’ Broadband Investments Require Enhanced Risk Management, April 17, 2023