Fitch: Municipal Utilities Takes Steps in California to Address Climate Change

AUSTIN, Texas--(BUSINESS WIRE)-- California's ambitious environmental agenda has triggered a radical transformation of the state's energy supply, with the promise of significant changes still to come in the second decade of this pursuit, according to Fitch Ratings. Driven largely by legislative initiatives requiring the expanded use of renewable energy resources and a reduction in greenhouse gas emissions, the state's policy objectives are having a direct impact on utility finances and operations. Thus far, California's public power utilities have risen to the challenge and preserved credit quality throughout the process, and Fitch expects this success to continue as the state pursues a new energy economy.

Beginning in 2006, the state's power utilities, including public power systems, began the process of complying with two key components of the enacted legislation - the renewable portfolio standard (RPS) and greenhouse gas emission reduction goals. The RPS is the principal standard driving the power supply transformation of public power utilities, as it requires power suppliers to generate or purchase an increasing portion of the electricity sold to retail customers from eligible renewable resources. The standard, which began at 20% in 2013, rises to 33% in 2020, before reaching a maximum of 50% by 2030. According to the California Energy Commission, California supplied nearly 21.9% of its energy from eligible renewable sources in 2014, up from 10.6% in 2008.

State legislation enacted in September 2016 requires a reduction in greenhouse gas emissions to 40% below 1990 levels by 2030. This supersedes the original goal set in 2006 that required a reduction to 1990 levels by 2020. While these increasing standards are also contributing to the addition of renewable resources, the RPS targets have been the primary factor in resource decisions. Public power utilities have also been directly impacted by 2006 legislation limiting investment in coal-fired generation beyond 2026. To comply, utilities have put in place the legal and operational components needed to divest themselves of two large coal-fired power plants - the San Juan Power Project located in New Mexico and the Intermountain Power Project located in Utah - that provide power to 13 public power utilities in California.

Complying with the myriad of environmental regulations has generally resulted in higher operating costs for California's public power utilities, which must be paid for by electric consumers. The higher costs are not only attributable to the addition of required renewable resources (including wind or solar generation), but also result from legacy costs related to the ownership of, or contractual positions in, existing resources (coal and natural-gas fired generation and large hydro projects) that cannot be easily or quickly terminated. Moreover, the recovery of these costs has been hampered by lower utilization as energy sales are generally not increasing in California. Although customer growth continues, conservation and energy efficiency gains have led to flat or declining energy sales.

Upward cost pressure at most public power utilities has been moderated by the downward price trend in renewable energy prices over the past decade and the laddering in of new capacity, as well as by low natural gas prices, but electricity price increases continue to outpace the rest of the nation. While California's average residential price of electricity increased 48% over the last decade according to the U.S. Energy Information Administration, the national average increased only 32% over the same period.

Public power utilities have generally passed the full cost of compliance through to consumers, which has resulted in higher electric rates, but preserved financial margins and credit quality through this period of transformation.

Fitch expects the trend of higher costs and full recovery to continue, and public power credit quality to remain strong through the second decade of transformation. Despite the potential for continued escalation in environmental standards and related costs, public power utilities have established utility practices to stabilize performance, including improved rate structures that better accommodate the cost variability of renewable supplies and compensate for lower load growth. Moreover, further declines in renewable energy costs due to improvements in technology and efficiency, together with projected low natural gas prices, should aid the overall cost profile of the state's public power utilities.

Additional information is available at 'www.fitchratings.com'.

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Source: Fitch Ratings

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