Fitch Publishes U.S. Competitive Generators Handbook
The genco sector comprises both affiliates of regulated utilities (affiliated gencos) and independent power producers (IPPs). The affiliated gencos typically operate within a larger holding company structure and generally boast strong investment-grade credit metrics, such as PSEG Power LLC ('BBB+'), Southern Power Co. ('BBB+'), and Exelon Generation Co. LLC (Exgen, 'BBB'). IPPs such as Calpine Corporation (Calpine, 'B+') are viewed as riskier and typically rated below investment grade.
Fitch continues to have a negative outlook for the competitive generation sector, reflecting poor sector fundamentals that include weak electricity demand, robust reserve margins in most nonregulated markets and low power prices. In addition, the rapid expansion of renewables, driven by state mandates and federal policy initiatives, will intensify pressure on heat rates and power prices in many regions. The reliability-driven enhancement to the capacity constructs in the PJM Interconnection (PJM) and ISO New England (ISO-NE) markets is a positive.
Given the sharp drop in power prices since last year and no material recovery in sight, Fitch's primary concerns revolve around the commodity exposure for gencos once the current above-market hedges expire. The waning liquidity in forward markets and, in many cases, management's robust proprietary views have led to many gencos hedging below ratable levels. Ownership of a competitive retail business (which is typically countercyclical to wholesale generation), a track record of long-term bilateral contracts and visibility on capacity revenues can provide favorable offsets.
With most gencos operating toward the upper end of targeted leverage metrics, there is limited headroom to withstand a deepening cyclical trough. On the positive side, free cash flow and liquidity are robust and debt maturities are manageable. Some IPPs have used the upswing in the commodity cycle and accommodative capital markets to raise senior unsecured debt, thus gaining flexibility in their capital structure. Given depressed equity valuations, aggressive return of capital to shareholders is a key credit risk.
The report is available on the Fitch web site at 'www.fitchratings.com'.