Fitch downgrades Southern Co. over combination of Kemper and Vogtle issues

Fitch Ratings said June 5 that, largely due to the costly Kemper County coal gasification project, it has downgraded Mississippi Power‘s Long-term Issuer Default Rating (IDR) to ‘BBB+’ from ‘A-‘ and Short-term IDR to ‘F2’ from ‘F1’.

The Rating Outlook for Mississippi Power remains Negative. Mississippi Power is a wholly owned subsidiary of Southern Co. (NYSEL SO). Fitch said it has affirmed the IDR for Southern at ‘A’ and revised its rating Outlook to Negative from Stable.

Fitch has affirmed the IDRs for Southern’s other subsidiaries as follows: Alabama Power at ‘A’; Georgia Power at ‘A’; Gulf Power at ‘A-‘; Southern Power at ‘BBB+’, and Southern Electric Generating Co. (SEGCO) at ‘A’. The Rating Outlook for these entities is Stable. Fitch has also affirmed the ‘F1’ commercial paper rating for Southern Company Funding Corp.

The downgrade and continuation of the Negative Rating Outlook for Mississippi Power is driven by still elevated risks surrounding the Kemper County Integrated Gasification Combined Cycle (IGCC) project, which include the regulatory uncertainty around the recovery of costs and execution risk associated with the completion of the project within currently estimated cost and timeline. Specifically, Fitch said it is concerned with the inability of Mississippi Power to reach a settlement with the Mississippi Public Utility Staff (MPUS) on Kemper cost recovery and the uncertainty induced by Mississippi Supreme Court’s unfavorable decision that voids the current rate plan in effect.

A further delay in schedule and cost escalation cannot be ruled out and Fitch is worried about any potential disallowance of Kemper construction costs in the prudency reviews to be conducted by the Mississippi Public Service commission (MPSC). The terms of all three commissioners expire this year and the two commissioners who have supported Kemper do not plan to re-run, thus, exacerbating the regulatory overhang, Fitch noted. As an added blow, South Mississippi Electric Power Association‘s (SMEPA) recent decision to terminate the asset purchase agreement for a 15% ownership in Kemper saddles Mississippi Power with incremental capacity, a substantial portion of which may have to be sold as merchant, Fitch pointed out.

The strong rating linkages with the parent company are limiting further negative rating actions for Mississippi Power at this time. Southern has demonstrated tangible financial support by absorbing a substantial portion of the Kemper cost overrun through equity infusion in Mississippi Power, Fitch reported.

The Outlook revision to Negative for Southern Co. is driven by the simultaneous undertaking of two large and complex generation projects: the Kemper IGCC project and Vogtle nuclear units 3 and 4 in Georgia, both of which have seen material construction delays and rising regulatory concerns, which have weakened the profile of Southern at its current rating level. Southern’s current and forecasted credit metrics, while consistent with historical measures, do not adequately offset the enhanced business risk that is expected to linger until the two projects enter successful operations, Fitch wrote.

Southern has issued $1.5 billion in equity over 2013-2014 to fund a substantial portion of Kemper cost overruns, which has been a key ratings driver supporting the company’s ‘A’ IDR and Stable Outlook until now. However, Fitch believes that management’s appetite for further equity issuance to support future cost overruns at Kemper or finance Southern Power’s growth aspirations is limited at this point, which could result in higher than expected parent company debt issuance, thereby putting pressure on consolidated credit metrics.

Fitch says some issues could be resolved within next two years

Fitch said it will resolve the Negative Outlook over the next 12-24 months based on the successful completion and operations of Kemper, resolution of regulatory uncertainty in Mississippi and issuance of approximately $1 billion in securitization proceeds at Mississippi Power. At the same time, Fitch will continue to monitor the construction progress of the new Vogtle nuclear units based on the current costs and schedule and continuation of regulatory support for Georgia Power as demonstrated through future Vogtle Construction Monitoring (VCM) proceedings and the next general rate case filing in mid-2016.

Fitch’s rating concerns for Southern include significant construction and regulatory risks associated with the two large baseload projects under construction: the 2,200-MW Vogtle nuclear units 3 and 4 in which Georgia Power owns a 45.7% stake and the 580-MW Kemper IGCC plant being built by Mississippi Power.

The Kemper project has faced significant overruns relative to its original project cost estimate. The project is now expected to cost $6.2 billion, of which $1.3 billion is subject to exemptions and exceptions from the regulatory cost cap. Of the remaining $4.9 billion, Mississippi Power does not intend to seek rate recovery for $2.1 billion of costs incurred above the $2.88 billion cost cap and has taken an equivalent charge to income through its 1Q 2015 financial results. With the project close to 88% complete, future cost increases may not be material. But Fitch noted that the project is entering a crucial phase of gasifier start up and integration with the combined cycle units. Issues with start-up activities could delay the operational date (currently estimated as first half of 2016) that exposes Mississippi to additional costs (approximately $15 million-$40 million per month) and greater regulatory risk.

On the positive side, Southern’s utilities have witnessed an improving trend in customer sales and electricity sales as their service territories continue to benefit from economic rebound, job growth and population in-migration. On a combined basis, customer count grew by 0.8% in 2014 and retail sales grew by 3.3%. Industrial sales exceeded expectations with a 3.3% GWH sales growth in 2014 reflecting a rebound across most of the major industrial segments. Industrial sales have shown positive year-over-year growth for eight consecutive quarters now. Residential sales are also trending above expectations, while commercial sales continue to be soft. Fitch’s financial forecasts embed a 0.5%-1.0% sales growth across most of Southern’s utility subsidiaries.

Fitch expects Southern’s consolidated environmental compliance expenditures to wind down after 2015, a majority of which is being spent to meet the federal Mercury and Air Toxics Standards (MATS). The company is planning to spend approximately $2.1 billion over 2015-2017 on environmental capex. All of Southern’s regulated subsidiaries, with the exception of Georgia Power, have environmental trackers. Georgia Power has typically recovered environmental compliance-related costs through base rate case decisions.

Alabama Power’s large coal mix (approximately 55% of total generation) leaves the utility exposed to potential higher environmental expenditures, Fitch wrote. While Alabama Power has an environmental clause that allows for recovery of all prudent and mandated expenditures, the retail electricity rates would rise, reducing the flexibility for Alabama Power to increase the base rates to earn an attractive return on equity (ROE).

Georgia Power’s annual capex is forecast to be in the $2.0 billion-$2.4 billion range over 2015-2017 and is primarily driven by its share of Vogtle costs. Georgia Power environmental capex is winding down and the company anticipates spending approximately $750 million over 2015-2017 mostly for compliance with the MATS rule. While Georgia regulations do not allow for automatic recovery of environmental costs, Georgia Power has historically been granted adequate rate relief on its environmental capex.

Southern Power is well-positioned relative to other power generators in the face of more stringent environmental regulations that affect coal- and oil-fired generation. Its fleet of modern gas-fired power plants comprise 94% of the currently installed capacity of 9,121 MW. Fitch expects Southern Power’s gas generation fleet to benefit from potential retirement of old and inefficient coal capacity in its region.

Southern Power has been expanding its solar portfolio, which Fitch views as neutral to its credit profile. Southern Power currently owns ownership interest in approximately 405 MW of installed solar PV projects and has approximately 360 MWs under construction. The entire output from these facilities has been contracted under long-term power purchase agreements (PPA) with the local regulated utilities. The company recently announced its first wind acquisition, the Kay Wind facility, a 299 MW wind project in Oklahoma that is expected to begin commercial operations in late 2015 and has a 20-year PPA for its output.

Southern Power continues to scout for new investment opportunities that include utility-scale solar, wind projects and natural gas-fired plants. Fitch said it expects Southern Power to finance new projects and/or acquisitions with 50%-55% debt structure.

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.