Fitch Ratings said Nov. 18 that it has affirmed Ohio Valley Electric Corp.’s Long-Term Issuer Default Rating (IDR) and senior unsecured debt rating at ‘BBB-‘.
The Rating Outlook has been revised to Negative, Fitch added.
OVEC, which is owned by a consortium of power producers like American Electric Power (NYSE: AEP) and FirstEnergy (NYSE: FE), controls the coal-fired Clifty Creek and Kyger Creek power plants. AEP and FirstEnergy have over the last couple of years worked to get their shares of the plants protected through firm power sales agreements in Ohio’s deregulated utility market.
The Negative Outlook decision by Fitch follows FirstEnergy’s recent announcement that it is reviewing strategic options for its merchant subsidiary FirstEnergy Solutions Corp. (FES), including bankruptcy. FES currently holds a 4.85% entitlement in OVEC’s intercompany power agreement (ICPA). A default at FES could subject OVEC to a permanent revenue shortfall given that sponsors are severally responsible for their shares of OVEC’s operational and financial obligations under the terms of the ICPA, said Fitch.
OVEC has sufficient liquidity, in Fitch’s opinion, to face a brief modest revenue shortfall. However, further negative rating actions are likely if there is a high probability that FES will reject its OVEC obligations under a bankruptcy proceedings and that OVEC will not be able to replace in a timely manner the loss of this sponsor, through substituting a new sponsor or establishing a reserve to offset the long-term revenue shortfall.
Fitch said that OVEC’s credit profile is derived from the legal enforceability of the ICPA between OVEC and its sponsors as well as the credit profiles of its sponsors. Due to the diversity of the sponsor base, Fitch takes into consideration the average credit profile of the sponsors rather than tying OVEC’s ratings to that of the lowest-rated sponsor.
Following approval by the Public Utilities Commission of Ohio of an eight-year power purchase agreement for Ohio Power‘s (an AEP subsidiary) OVEC entitlements, sponsors representing nearly 80% of OVEC’s generation capacity can recover their OVEC-related costs either through a regulatory construct or through sponsors’ membership charter provisions. OVEC’s variable energy costs compare favorably with wholesale energy prices in the PJM Interconnection and Midcontinent Independent System Operator (MISO) regions. However, Fitch estimates that all-in costs exceed prevailing merchant prices, even when factoring in revenues from PJM’s capacity market auctions. Thus, the continued ability of the sponsors to recover OVEC-related costs during the currently depressed wholesale market conditions is an important rating driver.
The ICPA restricts the transfer of sponsoring rights and obligations to entities with investment grade credit ratings; however, there is no provision if a sponsor fails to maintain an investment-grade credit profile. Three sponsors, collectively responsible for 12.76% of OVEC’s financial obligations, have slipped to speculative credit profiles. Fitch views as challenging the transfer of the rights and obligations under the ICPA to a new sponsor in an environment of low merchant power prices and secular trend toward lower-carbon generation capacity.
OVEC has sufficient liquidity to meet a temporary revenue shortfall, with $115 million available under its revolving credit facility and $124 million in long-term financial investments at Sept. 30, 2016. However, OVEC does not have, in Fitch’s opinion, the financial resources to absorb a permanent revenue shortfall. Thus, mitigating actions by shareholders or remaining sponsors would be required to maintain the current ratings.
OVEC’s two coal plants maintain favorable availability factors and heat rates despite their age, averaging about 70% and 10,600 Mbtu/MWh respectively in the 2013-2015 period. Cost reduction initiatives and pro-active management of coal supplies resulted in reduction in energy costs since 2013, with electricity charges expected to remain below $30/MWh over the medium-term, Fitch noted. The integration of OVEC’s generation capacity into the PJM market, effective since May 2016, allows for economic dispatch of the individual generating units as well as participation in the capacity performance market. Management expects this will support higher capacity utilization over the medium-term.
Management forecasts modest environmental capex spending in the 2017-2024 period, as the plants are currently compliant with MATS and CSAPR requirements. The impact of the Clean Power Plan currently falls outside the rating horizon.
Fitch’s key assumptions within the rating case for OVEC include:
- Average usage factor of 75% in 2017-2019;
- Operating costs increasing by 1% annually; and
- Debt repayments limited to amortization schedule.
Fitch would affirm the ratings should the financially stressed sponsors transfer their obligations to entities with investment grade profiles. Modification of the ICPA, incremental contributions or other similar mitigating actions from remaining sponsors or shareholders to permanently offset the loss a sponsor could also stabilize the ratings. “Ratings upgrade is unlikely given that OVEC’s credit profile is constrained by its sponsors’ credit ratings and increasingly stringent environmental emission mandates,” wrote Fitch.
Said FirstEnergy in its Nov. 4 quarterly Form 10-Q filing with the SEC: “FirstEnergy’s strategy is to be a fully regulated utility focusing on stable and predictable earnings and cash flow from its regulated business units. In order to execute on this strategy, FirstEnergy has begun a strategic review of its competitive operations focused on the sale of gas and hydroelectric units as well as exploring all alternatives for the remaining generation assets at [FirstEnergy Solutions] and [Allegheny Energy Supply]. These include, but are not limited to, legislative efforts to convert generation from competitive operations to a regulated or regulated-like construct such as a regulatory restructuring in Ohio, offering generation into any process designed to address [Monongahela Power‘s] generation shortfall included in its IRP, and/or a solution for nuclear generation that recognize their environmental benefits. Management anticipates that the viability of these alternatives will be determined in the near term with a target to implement these strategic options within the next 12 to 18 months and could result in material asset impairments.
“Material asset impairments resulting from the sale or deactivation of generation assets or from a determination by management of its intent to exit competitive generation assets before the end of their estimated useful life resulting from the inability to implement alternative strategies discussed above, adverse judgments or a FES bankruptcy filing could result in an event of default under various agreements related to the indebtedness of FE. Although management expects to successfully resolve any FE defaults through waivers or other actions on acceptable terms and conditions, the failure to do so would have a material and adverse impact on FirstEnergy’s financial condition, and FirstEnergy cannot provide any assurance that it will be able to successfully resolve any such defaults on satisfactory terms.”