Fitch downgrades IPALCO in part on coal plant emissions concerns

Fitch Ratings said April 18 that, in part due to clean-air compliance concerns at coal-fired plants in Indiana, it has downgraded the Issuer Default Rating (IDR) of IPALCO Enterprises (IPALCO) to ‘BB+’ from ‘BBB-‘ and downgraded the instrument rating of IPALCO’s senior secured notes by one notch to ‘BB+’ from ‘BBB-‘.

In addition, Fitch has affirmed the IDR of Indianapolis Power & Light (IPL), IPALCO’s wholly owned subsidiary, at ‘BBB-‘ as well as affirmed IPL’s security ratings. About $1.8bn of outstanding debt is affected by these rating actions. The rating outlook is Stable.

IPALCO is a holding company and is a subsidiary of “highly leveraged” parent AES Corp. (NYSE: AES), Fitch noted. IPALCO’s ratings reflect its highly leveraged capital structure and the sole support it receives from the upstream distributions from IPL. The one-notch downgrade to IPALCO’s IDR reflects Fitch’s expectation of weakening credit metrics primarily due to significant levels of capital spending for environmental compliance at IPL.

In order to comply with the U.S. Environmental Protection Agency’s Mercury and Air Toxics Standards (MATS), IPL has publicly stated that it may need to spend between $500m-$900m over the 2012-16 period. In its rating case, Fitch has assumed that the environmental expenditures will be toward the midpoint of this range.

IPL owns about 3,600 MW of generation assets, of which 79% is coal-fired. The five largest and most economical units are Harding Street 7 and Petersburg 1-4, which represent aggregate nameplate capacity of greater than 2,300 MW, or more than 80% of IPL’s total coal fleet, Fitch noted. To comply with MATS, IPL is considering incremental investments for those units, such as installing fabric filters (baghouses) and/or active carbon injection to control mercury, upgrading existing electrostatic precipitators on Petersburg 3-4, and replacing wet ash ponds with dry ash disposal.

The remaining six units are relatively small (less than 120 MW each), and have been identified by Fitch as candidates for retirement. Fitch said its current forecasts do not incorporate any capital expenditures for replacement capacity that might be needed in the 2016 timeframe.

All environment compliance expenditures are likely to be recoverable in customers’ rates, Fitch pointed out. Indiana Senate Bill 29 established the Environment Compliance Cost Recovery Adjustment (ECCRA) mechanism, which allows for full recovery of environmental projects and expenditures relating to controlling air emissions. Indiana Senate Bill 251, which became law in May 2011, covers costs of other federal mandates, such as costs relating to EPA regulations of cooling water intakes or ash disposal.

As a result of this Indiana ratemaking authority, Fitch expects timely recovery on the environment expenditures without a requirement of a base rate application. So, Fitch is forecasting the decline in credit metrics at IPALCO to be temporary over the 2012-2015 period and expects credit metrics to recover by 2016.

IPL outlined air emissions status in latest Indiana case

IPL got its latest ECCRA approval on March 28 from the Indiana Utility Regulatory Commission (IURC). Within that case, IPL said that it is pursuing a number of options to meet the new Cross-State Air Pollution Rule (CSAPR) SO2 requirements. Among other things, IPL previously upgraded the emission reduction capability of the Petersburg Unit 3 flue gas desulfurization (FGD) equipment, commenced operation of the new FGD on Harding Street Unit 7 and completed and placed into operation the Petersburg Unit 4 FGD upgrade. The purpose of the Unit 4 FGD upgrade is to increase the SO2 removal efficiency of the unit to 95%, which will result in an estimated additional removal of 14,000 tons per year of SO2.

With the successful upgrade of the Petersburg Units 3 and 4 FGDs, the Harding Street Unit 7 FGD installations, and the operation of Petersburg Units 1 and 2 FGDs, IPL projected that it will materially meet the new SO2 emission reduction requirements. However, as it has done in the past, IPL may need to supplement its compliance with the purchase of allowances on the open market.

Also, from 2009 through the end of 2011, IPL completed much of the work for the Petersburg Units 2 and 3 selective catalytic reduction (SCR) systems. The next scheduled outages for these units are in the spring of 2012 and the fall of 2012, respectively. Most of the remaining tasks cannot be performed while the equipment is in operating mode. For this reason, only Unit 2 activities are planned for the next six month period relating to the SCR reactors, the IURC approval order said.

IPALCO outlines some compliance plans, costs

IPALCO said in its Feb. 27 annual Form 10-K report about compliance with MATS, which is also known by another name: “We are currently reviewing the impact of the new HAPS rule (the ‘Utility MACT’) and estimate additional capital expenditures related to this rule for environmental controls for our baseload generating units to be approximately $500 million to $900 million through approximately 2016.”

The Form 10-K later added: “The combination of existing and expected environmental regulations make it likely that we will temporarily or permanently retire several of our existing, primarily coal-fired, smaller and older generating units over the next several years. These units are not equipped with the advanced environmental control technologies needed to comply with existing and expected regulations, and collectively make up less than 15% of our net electricity generation over the last several years. We are continuing to evaluate available options for replacing this generation, which include modifying one or more of the units to use natural gas as the fuel source, building new units, purchasing existing units, joint ownership of generating units, purchasing electricity in the wholesale market, or some combination of these options.”

The Form 10-K gives these coal plants and winter generating capacity for each: Petersburg, four coal units, 1,752 MW; Harding Street, three coal units, 645 MW; and Eagle Valley, four coal units, 263 MW.

The Form 10-K said about compliance with CSAPR, which is currently stayed by a federal appeals court: “Currently, we plan to operate previously-installed pollution control equipment, use low-sulfur coal when cost-effective, and purchase allowances when and if it is necessary to comply with CSAPR. SO2 and NOx allowance prices are currently expected to be significantly higher for the next few years. Because SO2 allowances are not recoverable, our allowance expense could be material if we need to purchase them. We are unable to predict whether or not we will need to purchase allowances as this will be significantly impacted by energy demand, wholesale prices, generating unit reliability and whether or not we retire some of our older units. If CSAPR is reinstated, it could also have the effect of increasing our costs to produce electricity, which will have a negative impact on our wholesale sales volumes and margins.”

About Barry Cassell 20414 Articles
Barry Cassell is Chief Analyst for GenerationHub covering coal and emission controls issues, projects and policy. He has covered the coal and power generation industry for more than 24 years, beginning in November 2011 at GenerationHub and prior to that as editor of SNL Energy’s Coal Report. He was formerly with Coal Outlook for 15 years as the publication’s editor and contributing writer, and prior to that he was editor of Coal & Synfuels Technology and associate editor of The Energy Report. He has a bachelor’s degree from Central Michigan University.