fitchratings 1 credit outlook u.s. power and gas richard hunter managing director, north america...

11

FitchRatings

CreditCredit OutlookOutlook U.S. Power and GasU.S. Power and Gas

Richard HunterRichard HunterManaging Director, North AmericaManaging Director, North America

Global Power GroupGlobal Power Group

Energy Finance & Credit Summit, Houston, February 2004Energy Finance & Credit Summit, Houston, February 2004

Return to Risk Limited website: www.RiskLimited.com

22FitchRatings

Capital Markets EnvironmentCapital Markets Environment Credit EnvironmentCredit Environment Major ThemesMajor Themes Outlook for the SectorsOutlook for the Sectors

UtilitiesUtilities Utility Parent Holding CompaniesUtility Parent Holding Companies Competitive Gencos & Energy MerchantsCompetitive Gencos & Energy Merchants

TopicsTopics

33FitchRatings

Capital Markets EnvironmentCapital Markets Environment

1999 -20021999 -2002 Excessive capital market exuberanceExcessive capital market exuberance

Late 2002- Late 2002- January 03January 03

Reaction: “Liquidity Black Hole”Reaction: “Liquidity Black Hole”Credit market and bond market showed a strong Credit market and bond market showed a strong linkage to the equity marketlinkage to the equity market

Bank consolidation has reduced diversityBank consolidation has reduced diversity

20032003 Capital and credit market access restoredCapital and credit market access restoredPrivate investment sources provided liquidityPrivate investment sources provided liquidity

Pure utilities & public power retained market access Pure utilities & public power retained market access

Current Current 20042004

Low interest rates, good market accessLow interest rates, good market access

44FitchRatings

Equity and Debt Capital MarketsEquity and Debt Capital Markets

0

20

40

60

80

100

120

1Q 01 2Q 01 3Q 01 4Q 01 1Q 02 2Q 02 3Q 02

Bond

Equity

55FitchRatings

Equity and Debt Capital MarketsEquity and Debt Capital Markets

0

20

40

60

80

100

120

1Q 01 2Q 01 3Q 01 4Q 01 1Q 02 2Q 02 3Q 02 4Q 02 1Q 03 2Q 03 3Q 03 4Q 03

Bond

Equity

1Q 03

Source: Merrill Lynch, Bloomberg

66FitchRatings

Near-term OutlookNear-term Outlook

Gas price volatility and commodity price riskGas price volatility and commodity price risk Merchant power overbuilt in nearly all regionsMerchant power overbuilt in nearly all regions Pendulum swings back toward integrated utilities Pendulum swings back toward integrated utilities

and regulationand regulation System reliability and environmental protection System reliability and environmental protection

require higher capital spendingrequire higher capital spending Low interest rate environment is benign for Low interest rate environment is benign for

capital intensive and over-leveraged sector, but capital intensive and over-leveraged sector, but higher rates may lie aheadhigher rates may lie ahead

Mergers and consolidations are likelyMergers and consolidations are likely

77FitchRatings

Longer- Term IssuesLonger- Term Issues Global WarmingGlobal Warming

Carbon tax in our future?Carbon tax in our future? Price elasticity, “demand destruction” and demand-side Price elasticity, “demand destruction” and demand-side

management, obsolete technologiesmanagement, obsolete technologies Is wired distribution of power a post-mature industry? Is wired distribution of power a post-mature industry? How much new investment is needed?How much new investment is needed?

Distribution and transmission:Distribution and transmission:

• Patch up the old system, orPatch up the old system, or

• Invest heavily in an intelligent wired networkInvest heavily in an intelligent wired network Power productionPower production

• Retrofit old thermal generation, orRetrofit old thermal generation, or

• Invest in new technologiesInvest in new technologies

88FitchRatings

Credit EnvironmentCredit Environment

2003 vs. 20022003 vs. 2002

0

10

20

30

40

50

60

70

Q103 Q203 Q303 Q403

0

10

20

30

40

50

60

70

Q102 Q202 Q302 Q402

Downgrades

Upgrades

Credit stress increased through 2002 and stabilized in 2003.

Source: Fitch Ratings

99FitchRatings

Credit Outlook by Sub-sectorCredit Outlook by Sub-sectorJanuary 1, 2003 January 1, 2003 January 1, 2003 January 1, 2003

January 1, 2004 January 1, 2004 January 1, 2004 January 1, 2004

Parent CompaniesParent Companies Integrated UtilitiesIntegrated Utilities Distribution UtilitiesDistribution Utilities Diversified/Merchant Energy

Diversified/Merchant Energy

Note: Refers to the percentage of senior ratings in each sector with Positive Rating Outlook or Rating Watch status, Negative Rating Outlook or Rating Watch status or Stable Rating Outlook/Evolving Watch status.

Note: Refers to the percentage of senior ratings in each sector with Positive Rating Outlook or Rating Watch status, Negative Rating Outlook or Rating Watch status or Stable Rating Outlook/Evolving Watch status.

PositiveNegativeStable/Evolving

1010FitchRatings


Total Sector Power & GasTotal Sector Power & Gas 20032003 2002 2002 Upgrades to downgrades Upgrades to downgrades 1:21:2 1:12 1:12 Stable outlooks (at year end)Stable outlooks (at year end) 80%80% 64% 64% Negative to positive outlooksNegative to positive outlooks 2:1 2:1 6:1 6:1 Ratings stable, but low:Ratings stable, but low: Median RatingMedian Rating

• Competitive wholesale energyCompetitive wholesale energy BB• Regulated utility Regulated utility A-A-• Utility group parentUtility group parent BBB+BBB+

1111FitchRatings


Affiliate action as the largest single cause …Affiliate action as the largest single cause … Affiliate action as the largest single cause …Affiliate action as the largest single cause …

28

19 20 19

74

8

83

49

10 82 2

10

57

27

11 12

1 0

9

0

30

60

90

Group Linkage UnregulatedBusiness

RegulatedBusiness

Acquisitions Regulation Other External Other Internal

200120022003

Investor-Owned Power & Gas companies, All Rating Actions, Source: Fitch

1212FitchRatings

Regulated UtilitiesRegulated Utilities

The Morning After…The Morning After…

1313FitchRatings

Credit Outlook: Regulated UtilitiesCredit Outlook: Regulated Utilities

THEMESTHEMES

““Back to Basics”Back to Basics” Gas and power price Gas and power price

fluctuationfluctuation

Mandated capital Mandated capital spending for increased spending for increased reliability and supply reliability and supply securitysecurity

IMPLICATIONSIMPLICATIONS

Lower credit risk Lower credit risk Risk for utilities with Risk for utilities with

fixed tariffs and fixed tariffs and obligation to serve obligation to serve

Higher external Higher external financing needs financing needs (Potential mitigant: a (Potential mitigant: a clear regulatory clear regulatory recovery mechanism)recovery mechanism)

1414FitchRatings

Risks faced by Regulated Utilities Risks faced by Regulated Utilities

Commodity price riskCommodity price risk Ability to hedge commodity price risk Ability to hedge commodity price risk

Mergers and AcquisitionsMergers and Acquisitions Debt burdenDebt burden Unsuccessful merger/ consolidation implementationUnsuccessful merger/ consolidation implementation

Regulatory riskRegulatory risk Low interest rate, ergo low ROE Low interest rate, ergo low ROE Shifts in policyShifts in policy

1515FitchRatings


Lower Returns on Equity?Lower Returns on Equity?

0 5 10 15 20

8.0%-8.9%

9.0%-9.9%

10.0-10.9%

11.0%-11.9%

12.0%-12.9%

Source: PUR Utility Regulatory NewsSource: PUR Utility Regulatory News

1616FitchRatings

RoE impact on coveragesRoE impact on coverages

2.0x

2.4x

2.8x

3.2x

3.6x

4.0x

11.50% 10.50% 9.50% 8.50% 7.50% 6.50%

Median for BBB-

Operating Cash Flow/Interest Expense

assumes 50:50 debt:equity funding, 7% cost of debt, 35% tax rate

assumes 50:50 debt:equity funding, 7% cost of debt, 35% tax rate

1717FitchRatings


Success Rates?Success Rates?0 5 10 15 20

Rate Decrease

0% Increase

Increase <33% of request

Increase between 33% and 50%

Increase of 50% or more of request

Source: PUR Utility Regulatory NewsSource: PUR Utility Regulatory News

1818FitchRatings

Credit Outlook: Parent CompaniesCredit Outlook: Parent Companies

THEMESTHEMES ““Back to Basics” in 2004Back to Basics” in 2004

Prior unsuccessful Prior unsuccessful diversification activitiesdiversification activities

Industry consolidation Industry consolidation aheadahead

IMPLICATIONSIMPLICATIONS Lower business riskLower business risk

Need dividends from Need dividends from

utilities to reduce parent utilities to reduce parent debt; affects ability to debt; affects ability to fund capex fund capex

Event risk for both Event risk for both acquirers and targetsacquirers and targets

1919FitchRatings

Credit Outlook: Parent CompaniesCredit Outlook: Parent Companies

Analytical IssuesAnalytical Issues Parent-level debt service coverageParent-level debt service coverage

Tax-sharingTax-sharing Management feesManagement fees Subsidiary injectionsSubsidiary injections

Recovery AnalysisRecovery Analysis Non-consolidation in bankruptcyNon-consolidation in bankruptcy Parent-subsidiary notchingParent-subsidiary notching

2020FitchRatings

Competitive Wholesale and Competitive Wholesale and Merchant Energy CompaniesMerchant Energy Companies

Asset Sales

Equity Cash Flow

…exiting the debt hole

2121FitchRatings

What Does it Take?What Does it Take?

Example: Interest CoverExample: Interest Cover

0.0x

1.0x

2.0x

3.0x

4.0x

5.0x

6.0x

7.0x

8.0x

9.0x

10.0x

1999 2000 2001 2002 LTM

Industrials - BBB

All Regulated Utilities

All Parent Companies

All High Yield Unregulated


2222FitchRatings

How Deep is the Hole?How Deep is the Hole?

$136,000,000

$351,000,000

$51,000,000

Stand-alone UtilitiesIntegrated Utility GroupsWholesale Energy Companies

Debt Outstanding

Source: SNL, Inc.Data as at 9-30-03Source: SNL, Inc.

Data as at 9-30-03

2323FitchRatings

Sector High Yield Debt Sector High Yield Debt MaturitiesMaturities

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

$16,000

2004 2005 2006 2007 2008 2009

$m

per 12-17-03

per 2-17-04


2424FitchRatings

High Yield Debt MaturitiesHigh Yield Debt MaturitiesCompanyCompany Total 5 yearsTotal 5 years PeakPeak

Dec. 17, 2003Dec. 17, 2003 Feb 17, 2004Feb 17, 2004 Dec. 17, 2003Dec. 17, 2003 Feb 17, 2004Feb 17, 2004

Reliant Resources Reliant Resources & Orion Power& Orion Power

$ 6,400$ 6,400 $ 6,400$ 6,400 1Q 2007: $ 4,8771Q 2007: $ 4,877 1Q 2007: $ 4,8771Q 2007: $ 4,877

Calpine & subsCalpine & subs $ 9,286$ 9,286 $ 9,286$ 9,286 4Q 2004: $ 1,0484Q 2004: $ 1,048

$ 2,500$ 2,500

4Q 2004: $ 1,0484Q 2004: $ 1,048

$ 2,500$ 2,500

AES Corp.AES Corp. $ 3,018$ 3,018 $ 2,048$ 2,048 3Q 2007: $ 1,1933Q 2007: $ 1,193 3Q 2007: $ 6933Q 2007: $ 693

El Paso Corp.El Paso Corp. $ 5,176$ 5,176 $ 5,176$ 5,176 2005: $ 1,6002005: $ 1,600

2006: $ 1,7322006: $ 1,732

2005: $ 1,6002005: $ 1,600

2006: $ 1,7322006: $ 1,732

Allegheny Energy Allegheny Energy Inc. A E SupplyInc. A E Supply

$ 2,460$ 2,460 $ 662*$ 662* 1Q 2005: $ 1,0771Q 2005: $ 1,077 3Q 2005: $ 3003Q 2005: $ 300

1Q 2007: $ 3001Q 2007: $ 300

Dynegy HoldingsDynegy Holdings $ 1,742$ 1,742 $ 1,742$ 1,742 1Q 2005: $ 1,1391Q 2005: $ 1,139 1Q 2005: $ 1,1391Q 2005: $ 1,139

Aquila Inc.Aquila Inc. $ 1,272$ 1,272 $ 1,272$ 1,272 2Q 2006: $ 4452Q 2006: $ 445 2Q 2006: $ 4452Q 2006: $ 445

Source: Companies, Fitch Ratings

* assuming successful execution of refinancings currently in market

2525FitchRatings

Appetite for Roll-Over?Appetite for Roll-Over?

Oil, Gas, Pipeline & Oil, Gas, Pipeline & UtilitiesUtilities ( ($ bn)$ bn) 20032003 20022002 20012001 20002000

Loans + CommitmentLoans + Commitment 198.1198.1 226.1226.1 224.5224.5 174.5174.5

Classified Classified 38.038.0 17.017.0 4.34.3 4.04.0

Special Mention Special Mention 12.312.3 15.515.5 7.07.0 1.01.0

% Classified % Classified 19.5%19.5% 7.5%7.5% 1.9%1.9% 2.3%2.3%

% Special Mention % Special Mention 6.2%6.2% 6.9%6.9% 3.1%3.1% 0.6%0.6%

2626FitchRatings

Whose Loss is it Anyway?Whose Loss is it Anyway?

0

10

20

30

40

2002 2003

$bn

Non-Banks

Int'l Banks

U.S. Banks

Classified Commitments Classified as % of Commitment

0%

10%

20%

30%

40%

50%

2001 2002 2003

$bn

"Classified" Commitments on Syndicated Loans in excess of $20m

Source: Shared National Credit Survey, U.S. Federal Reserve Board

2727FitchRatings

Wholesale Energy MarketWholesale Energy MarketCompetitive GenerationCompetitive Generation

Current StatusCurrent Status Excess capacity, low spark spreadsExcess capacity, low spark spreads Speculative-grade ratings a barrier to negotiating Speculative-grade ratings a barrier to negotiating

term contractsterm contracts

Bankruptcies and restructuringsBankruptcies and restructurings Asset values at a cyclical low or permanently Asset values at a cyclical low or permanently

impaired?impaired? Jurisdictional issues about contract rejectionJurisdictional issues about contract rejection

2828FitchRatings

Wholesale Energy MarketWholesale Energy Market Competitive Generation Competitive Generation

Near-term OutlookNear-term Outlook Pendulum swings back toward integration and Pendulum swings back toward integration and

regulated utility power generationregulated utility power generation Examples: Examples: CA; AZ; WI CA; AZ; WI Load-serving entities shun executory contracts and Load-serving entities shun executory contracts and

dependence on gasdependence on gas Cost of capital advantage for utilities versus gencosCost of capital advantage for utilities versus gencos

2929FitchRatings

Option AOption A

Equity

3030FitchRatings

Equity performanceEquity performance

0

20

40

60

80

100

120

140

J-02

F-02

M-02

A-02

M-02

J-02

J-02

A-02

S-02

O-02

N-02

D-02

J-03

F-03

M-03

A-03

M-03

J-03

J-03

A-03

S-03

O-03

N-03

D-03

J-04

Dynegy

AES

Williams

Reliant

Calpine

El Paso

Monthly average share prices, indexed at 100 as at Jan. 1, 2002

Source: Bloomberg

3131FitchRatings

Option BOption B

Asset Sales

3232FitchRatings

Who's Buying?Who's Buying?

Source: Henwood Energy Services

0 1,500 3,000 4,500 6,000

Exelon

GoldmanSachs

TransCanada

Dominion

FPL

PSEG

Salt River

Brascan

DQE

MW 0 1,000 2,000 3,000 4,000

GoldmanSachs

Exelon

FPL

Dominion

TransCanada

PSEG

Salt River

Brascan

DQE

$m

3333FitchRatings

Sales characteristicsSales characteristics

22GW sold in past two years for c.$11bn22GW sold in past two years for c.$11bn Much of the value in contractsMuch of the value in contracts 60GW left on the block60GW left on the block Older contracts running offOlder contracts running off

Munis - self-build or fire sale?Munis - self-build or fire sale? LSEs - FERC warning shots?LSEs - FERC warning shots? Energy majors - Opposite direction?Energy majors - Opposite direction? Financial companies - Speculative??Financial companies - Speculative??

3434FitchRatings

Wholesale Energy MarketWholesale Energy MarketCompetitive GenerationCompetitive Generation

Regulatory and policy gridlockRegulatory and policy gridlock Bankruptcy Court versus FERC jurisdiction Bankruptcy Court versus FERC jurisdiction Congressional wrangling over Energy Policy ActCongressional wrangling over Energy Policy Act FERC versus states on RTOsFERC versus states on RTOs MISO members change their betsMISO members change their bets

3535FitchRatings

Wholesale Energy MarketWholesale Energy MarketFERC versus Bankruptcy CourtFERC versus Bankruptcy Court

If FERC prevails:If FERC prevails: If Bankruptcy Court prevailsIf Bankruptcy Court prevails::

A no-win situation for wholesale market competition

Lower asset recoveries for genco investors

Steeper cost of capital for gencos

Gencos less competitive

Utilities and PSCs will see greater risk to public in supply contracts

More incentive for utilities to build or buy power generation

Gencos less competitive

3636FitchRatings

Option COption C

Cash Flow

3737FitchRatings

Outlook: Competitive Wholesale Outlook: Competitive Wholesale Generators and MerchantsGenerators and Merchants

Regions - Generators by Rating

0% 20% 40% 60% 80% 100%

FL

SO

AEP

ERCOT

SPP

High IG Low IG High SG Low SG

Based on published and senior unsecured debt ratings, weighted by capacity



3838FitchRatings



0% 20% 40% 60% 80% 100%

FL

SO

AEP

ERCOT

SPP





3939FitchRatings



0% 20% 40% 60% 80% 100%

ENT

PJM

NY

CA





4040FitchRatings



0% 20% 40% 60% 80% 100%

ENT

PJM

NY

CA





4141FitchRatings

Regional Wholesale MarketsRegional Wholesale Markets

10

20

30

40

50

2004 2005 2006 2007 2008 2009 2010 2011 2012

$/M

wh

WECC - Southern CANE - PJM WestSE - EntergyMW - ComedERCOT - Houston

10

20

30

40

50

2004 2005 2006 2007 2008 2009 2010 2011 2012

$/M

wh

Source: Henwood Energy Services, Fitch Ratings

Market Clearing Price (Spring 2003) Market Clearing Price (Fall 2003)

4242FitchRatings

Regional Wholesale MarketsRegional Wholesale Markets

0

5

10

15

20

25

30

2004 2005 2006 2007 2008 2009 2010 2011 2012

$ m

illio

ns

WECC - Southern CA

NE - PJM WEST

SE - Entergy

MW - Comed

ERCOT - Houston0

5

10

15

20

25

30

2004 2005 2006 2007 2008 2009 2010 2011 2012

$ m

illio

ns

Net Revenues, hypothetical CC gas plant* (Spring 2003) (Fall 2003)

* Based on a combined cycle gas plant with a 6,900 Btu/Kwh heat rate, $2/Mwh variable O&M, and a 2% forced outage factor.

4343FitchRatings

Wholesale Energy MarketWholesale Energy MarketLonger-term OutlookLonger-term Outlook

Wholesale energy market will still exist, but no Wholesale energy market will still exist, but no guarantee that players will be the same.guarantee that players will be the same.

Broken models will be replaced by new and Broken models will be replaced by new and different models.different models.

4444FitchRatings

Wholesale Energy MarketWholesale Energy MarketLonger Term: Model 1Longer Term: Model 1

Utility

Merchant Producer

Merchant Producer

Distressed asset sale

Merger

Self-build

Consolidation and

Reintegration

4545FitchRatings


Utility

Project Developer

Project Developer

Asset lease

Build & transfer

Plant Operator

Service Contract

Preserves roles for specialists in project development and operation, but not a major role.

4646FitchRatings


Merchant Producer

Utility

Supply contract priced at floating market index

FinancialCounterparty

FinancialCounterparty

Financial hedge Financial

hedge

Consumers

Tariff adjustments

Both parties get the benefit of ‘Forward Contract’s provisions on the financial Hedge Contracts

Both assure physical supply and off-take in the Supply Contract

4747FitchRatings

Hong Kong SingaporeAustraliaFrance

USA SpainUKUSA

One State Street Plaza 2 Eldon Street 55 E. Monroe Street Rambla de Cataluna 124

New York City London Chicago Barcelona

NY 10004 EC2M 7UA IL 60603 E-08008

+1 212 908 0500 +44 20 7417 4222 +1 312 368 3100 +34 93 415 1823

25 rue Murillo 300 Queen Street Lippo Centre 7 Temasek Boulevard

Paris Brisbane 89 Queensway Singapore

75008 Queensland 4000 Hong Kong 038987

+33 1 44 29 91 29 +61 7 3222 8600 +852 2263 9963 +65 336 6801

www.fitchratings.com

Fitch Global Power GroupFitch Global Power Group

fitchratings 1 credit outlook u.s. power and gas richard hunter managing director, north america...

Documents

credit outlook

distribution of power

likely slide

fitch slide

power price fluctuation

credit market access

bloomberg slide

capital intensive