The 2012 drought, one of the most severe in recent memory, had profound economic effects across a broad array of industries (see note 1), and, not surprisingly, affected several electric utilities in the Pacific Northwest. These utilities rely heavily on hydroelectric energy, which supplies roughly 10% of our nation’s power (see note 2) but contributes a much higher percentage in this region, with some utilities obtaining as much as half of their energy in this manner in some years. These utilities face unique challenges, some of which have direct implications for credit quality.
Standard & Poor’s Ratings Services rates several integrated electric utilities in the northwestern U.S. with substantial hydroelectric power operations, including Idaho Power Co., Puget Sound Energy Inc., Avista Corp., PacifiCorp, and Portland General Electric Co.
Why have these utilities taken to using hydroelectric power to such an extent?
Hydroelectric power has several credit-supportive qualities that distinguish it from other types of generation. First, and perhaps most important, despite the staggering up-front costs of building dams and other facilities, maintenance capital spending is often considerably lower than for fossil fuel facilities or other types of comparably sized renewable energy facilities. For instance, fixed and variable operations and maintenance costs average $10/megawatt-hour (MWh) while a conventional coal facility averages $32.6/MWh (see note 3). This enhances credit quality from an operating efficiency standpoint: many utilities that have more conventional generation schemes have been dogged by unwieldy maintenance costs and insufficient or delayed recovery of these costs. The very nature of hydro facilities partially mitigates this risk. This is particularly helpful in forestalling regulatory lag where this is common.
Second, hydroelectric facilities may also be assigned the benefits of a renewable project. Variability in output has often been used as a critique of renewable power projects, but hydro projects are more efficient and less expensive on a MWh basis, and characteristically show somewhat higher capacity factors than other renewable projects (see note 4). Utilities in many states are now subject to renewable portfolio standards with varying degrees of intensity, and some, especially those in challenging regulatory jurisdictions or facing sputtering economic recoveries, are struggling to find cost-efficient and politically appealing ways to meet them (See “What Renewable Energy Standards Mean For U.S Electric Utilities’ Future,” published Oct. 4, 2012, on RatingsDirect. But some northwestern utilities, including Puget Sound Energy (see note 5), have been able to meet their burden in advance, using significant amounts of hydropower while still offering lower-than-average electric rates to customers; other utilities relying heavily on wind and solar to meet this threshold have been criticized for higher rates, though these are now partially masked by low natural gas prices. California, with its ambitious renewable mandate and customer rates far in excess of surrounding states, has had particular difficulty meeting its burden. Though there has been some controversy surrounding hydro’s classification as renewable, it is counted as such by every relevant state commission (see note 6); however, this often depends (as in Oregon and Washington) on meeting minimum efficiency standards, which may require additional capital spending, as was the case in 2012 with Puget Sound Energy’s Snoqualmie and Baker projects (see note 7). We view this as a credit enhancing facet; if a utility is forced to meet renewable standards, it’s more cost-efficient to do so with a more proven technology that provides minimal disruption to the current pricing scheme, and one that can enjoy regulatory and political support when it creates jobs.
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