FINANCE

Clean Power Plan offers concessions but is still a challenge -- utility analysts

Extended deadlines for action under the final Clean Power Plan are a boon to electric utilities, according to financial analysts.

Giving states two more years to start bringing down power-sector carbon emissions will allow companies to run inexpensive coal plants longer, avoiding early closure costs, according to Standard & Poor's Ratings Services. It will also make it easier for them to recoup the costs of replacement power, and it will ease grid reliability concerns that a tighter timeline may have raised, S&P says.

Moving the start of the interim compliance period to 2022, rather than 2020, could lower or delay needed customer rate increases, according to S&P.

The change could "contribute operational flexibility for meeting the regulatory standards and also provide a route for transitioning more smoothly to higher electric rates needed to support capital investments," S&P says. Analysts, however, are continuing to explore whether tougher compliance targets for some states will dilute those benefits (ClimateWire, Aug. 12).

The revised rule also gives states two more years, until 2018, to submit final carbon-cutting plans.

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Fitch Ratings said the timeline changes will "somewhat assuage a key concern voiced by utility managements."

"Nevertheless, compliance with the CPP will require significant infrastructure investment in building out renewable power generation and associated transmission networks as well as investments in natural gas pipeline infrastructure to facilitate coal to gas switching," Fitch said. "Given the long lead times required to plan and build these assets, we believe compliance by 2022 could still be a challenge for some states."

Overall, the final rule "offers some concessions" but will "nonetheless be a challenge for the U.S. power sector," Fitch says.

Unequal impacts on utilities

Regulated investor-owned utilities will likely benefit from the rule, even if they have significant exposure to coal, Moody's Investors Service says. That's because they can probably recover compliance costs by charging customers more for electricity.

S&P notes, though, that "if the costs of complying with the Plan are very onerous, rate-setting bodies might not be able to set rates at levels that can preserve credit measures and support existing ratings."

On the losing end of the rule are unregulated generators with coal exposure and public power utilities and cooperatives that rely more on fossil fuels and face much higher compliance costs, analysts say.

Merchant generators are most at risk from the Clean Power Plan, according to S&P. They don't have a way to recoup costs unless their plants can sell electricity competitively.

"This new regulation is a different sort of beast -- while previous efforts were designed as 'command and control'-type rules, requiring new technologies, this is likely to prompt more of a market-based system, in which coal plants are likely to be less competitive due to their more carbon-intensive nature," S&P says.

Stiffer goals

EPA's final rule is expected to cut nationwide power-sector carbon emissions 32 percent below 2005 levels by 2030, compared with 30 percent by 2030 in the draft rule.

"It may not look like a significant difference, but it is a significant difference," said Toby Shea, a Moody's vice president and senior analyst.

The rule incentivizes renewable power and existing nuclear plants, Moody's says. Shea said many states will choose to cap emissions outright, or use mass-based goals, rather than achieving an average fleetwide emissions rate. That means zero-carbon generation like renewables and nuclear, whether existing or new, will be valuable to meeting goals, he said.

The final rule, which projects more renewable energy growth, could have a neutral effect on gas generation, Moody's says. But analysts say they need to see state plans before they can predict the impact to various fuels.

"Gas generation has been growing and will continue to grow with or without the CPP. ... Given the amount of new renewables required to achieve the EPA's emission goals, renewables might crowd out some of gas generation's growth potential," Moody's says. "On the other hand, without the EPA's mandate, some of the coal plants may not be replaced with either gas or renewables."

Interstate efforts

Shea expects states will have to work together to trade compliance credits to achieve their goals.

"It's just not realistic -- it's inefficient for each state to meet their own goal without any kind of trading or sharing," Shea said.

S&P also says "it seems inevitable that, assuming the rule is upheld, states will bind together to meet reduction targets."

"The delays in the compliance period and the submission of [state implementation plans] should accommodate this, but the increased incentives for renewables inherent in this new rule also will foster cross-state connections -- after all, the major challenge of renewable assets is how much the sun shines and how much the wind blows, and having a wider geographic base across which to spread this risk partly mitigates this issue," S&P says. "In addition, many utilities and unregulated interconnections operate across state lines, so there are natural 'trading partners' in place already."

Utility CEOs had trading on the brain when they conducted quarterly earnings calls last week, shortly after the final rule came out.

Dynegy Inc. CEO Robert Flexon said his company was already meeting state emissions rate goals in every state except Illinois and Ohio, where Dynegy owns coal plants. Flexon said Dynegy would work with state agencies to write plans to reach target levels, using renewable energy or electricity conservation programs.

"If you look at our fleet outside of Illinois and Ohio, the emissions rates of our fleet versus the targets that those states have to get to, we're essentially a net -- we generate less emissions than what their rates are, so you are a beneficiary or providing beneficial services to that particular state in terms of bringing the average down," Flexon said.

Lynn Good, Duke Energy Corp.'s chairwoman and CEO, said the utility is exploring how the revised rule focuses more on market-based trading for compliance. Duke said the final CPP gives Duke easier targets to hit in North Carolina, South Carolina and Florida, and stiffer ones for plants in the Midwest.

Those impacts require more study, "and the compliance period will also be something we will digest," Good said on a conference call with securities analysts last week.

Dominion Resources Inc. CEO Thomas Farrell said rather than making broad generalizations about the rule, investment analysts should focus on each state's goals, existing generation mixes and capabilities.

"For example, if you look at the Southeastern states and the Midwestern states, where our pipeline assets are [well-positioned] ... gas-fired power will be able to meet the needs with the latest emissions targets," Farrell said. "So we're encouraged by that. I think that's good news -- opportunity for our infrastructure businesses."

Reining in power demand

Although energy efficiency capabilities are no longer calculated into state goals, S&P argues programs to reduce power demand are the "most economically efficient way of reducing carbon output."

"In particular, states with relatively low economic growth prospects in the future or which have not deployed these programs effectively in the past could benefit from this approach," S&P says. "However, we have observed that significant differences in building codes, the amount of new construction, and the relative contributions of commercial and industrial loads to demand can significantly influence utilities' ability to achieve efficiency gains."

Financial analysts note that legal and political challenges to the rule could determine how it impacts the power sector.

"We believe the final CPP rule will be litigated," Fitch says. "The judicial review process, along with the shifts in the political landscape [given that the state implementation plans will be finalized under the next administration], could drive the timing and severity of the CPP implementation."

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