The strength of a utility’s operational profile and
cost competitiveness is rooted in its portfolio of
power supply resources. Standard & Poor’s evalua-
tion also includes the analysis of the operating sta-
tistics of a utility’s power transmission, distribution,
and generating facilities. Efficiency measures,
including frequency and duration of unplanned
service interruptions, plant heat rates, and availabil-
ity and capacity factors, all are vital in determining
facility efficiency and ultimately the competitive
nature of an individual power plant, or the utility’s
overall cost profile.
Standard & Poor’s examines the diversity or con-
centration of resources and assesses the fuels upon
which a utility depends. This analysis explores
resource availability, reliability and cost.
Standard & Poor’s does not have a bias toward
owned or purchased resources, and the financial
analysis of a purchased power agreement will
equate fixed capacity payments with debt service
incurred when financing directly owned or jointly
owned generation assets in computing fixed charge
coverage. Rather, resource diversity, flexibility, and
cost competitiveness are the key determinants of
operational health.
Issues associated with purchased resources
include the level of demand charges, unique con-
tract terms and duration of contracts, and the abil-
ity to take advantage of market opportunities. An
important component of the power supply evalua-
tion is an assessment of a utility’s fuel mix, supply
arrangements, fuel costs, and any financial or other
hedging mechanisms designed to control fuel risk.
Fuel contract terms, especially pricing conditions,
duration, reopener options, and minimum take
provisions will be examined. Standard & Poor’s
will look for a balance in the length and nature of
these supply contracts, and for each utility will
determine the degree of risk associated with its fuel
purchasing practices.
Standard & Poor’s will explore the degree of
sophistication and the checks and balances used in
conjunction with any hedging program. Crucial to
the analysis of an issuer’s fuel mix and purchased
power mix is an assessment of counterparty risk.
This includes an analysis of wholesale contracts
with regard to duration, termination provisions,
price, and the extent to which they add a fixed
component to the financial profile. Coal, gas, and
nuclear-fired generation at various times have fallen
in and out of favor. As such, a diverse mix of fuel
that enables a utility to employ cost efficient gener-
ation is viewed as a strong operational component.
Prepaid power purchase agreements typically
offer the buyer favorable inducements such as dis-
counts, and can be funded with tax-exempt debt
issued by municipal issuers. For debt-financed, pre-paid power contracts, the principal and interest
payments are treated similar to capacity payments
of the more traditional purchased power agree-
ments. Operational considerations include the
source and nature of the contracted power supply,
which may be unit specific or from a more diverse
pool of generation assets; the amount of the com-
modity purchased relative to the issuer’s total sup-
ply needs; contract duration; and creditworthiness
of the power supplier. Contract terms are also scru-
tinized, and should provide bondholders with pro-
tection in the event the counterparty fails to
perform its contractual obligations.
For prepaid natural gas transactions, the treat-
ment of the debt issued to fund the prepayment is
slightly different than that of prepaid power con-
tracts, since pay-as-you go gas supply purchase
agreements do not typically have a capacity com-
ponent imputed, as with purchase power agree-
ments. The annual amount of the debt service on
the prepaid bonds is typically sized to approximate
the cost of gas that would arise had the gas been
purchased under a long-term gas purchase agree-
ment, so the impact on cash flow under either sce-
nario is minimal, as long as the supplier continues
to perform.
For prepaid gas transactions involving directly
issued debt or involving third party conduits such
as joint action agencies, debt service is calculated or
imputed to measure the transactions impact on debt
ratios. However, the qualitative factors that miti-
gate potential pitfalls usually associated with debt
leverage, such as the risks of load loss, supplier per-
formance and remarketing, will be taken into con-
sideration. Therefore, although evaluated on a
case-by-case basis, debt-financed prepaid gas con-
tracts, so long as their terms do not give rise to sig-
nificant additional operating risks, and if structured
so that counterparty risks and remarketing risks are
mitigated, generally should have a neutral impact
on credit quality when compared to a pay-as-you
go gas purchase agreement
Costs of historical investments in generating
plants continue to represent a significant challenge
to utilities and frequently are a significant element
underlying above-market rates. Investment is meas-
ured in terms of the amount of debt that has been
incurred and the associated costs of servicing debt
in relation to kWh sold, kWh of demand, kW of
installed capacity, and the number of customers
served by the system. Again, fixed capacity pay-
ments made under purchased power agreements
will be factored into the analysis, equating such
payments with principal and interest on generation-
related debt. In the event that a municipal electric
utility is faced with a deregulated retail environ-
ment, the elimination of stranded costs is critical toGeneral Government Utilities122 Standard & Poor’s Public Finance Criteria 2007