US creditors wise up to ESG utility risk

IFR 2307 - 02 Nov 2019 - 08 Nov 2019
5 min read
William Hoffman

Utilities face a wide range of well-known climate change risks, but more traditional credit factors and an overall strong economy have allowed US investors to push aside such challenges — until recently.

There was investor push back on the slew of utilities names that issued new bonds in recent months, according to two syndicate bankers close to the trades.

"We are hearing increasing chatter about shying away from - or having less appetite for - utilities that have heavy coal bases in terms of their generation portfolio," one syndicate banker said.

"Investors have been discussing this for a while but we hadn't seen it manifested in behaviour around orders and pricing indications, but I think with these trades we were seeing folks scale back their appetite."

The impact was made most apparent when American power company Ameren came to the market with two bonds in September: a US$450m 2.5% five-year on September 11 followed by Ameren Missouri's US$330m 3.25% 30-year on September 23.

Both seemed to perform decently but the Ameren Missouri plant has specific coal-related issues that may have made it less attractive than its parent.

The bond from Ameren tightened 23bp through price progression and garnered a US$2.2bn order book 4.8 times over subscribed. The bond from Ameren Missouri, however, tightened just 13bp from initial price thoughts and built a smaller US$800m order book 2.4 times over subscribed.

Ameren's handling of its Missouri coal plant is under scrutiny as fumes have polluted the surrounding air for years and the company is refusing to clean leakage-prone ash ponds that could impact water supply.

Sure enough, the risks proved real as a federal judge in late September found the plant in violation of the Clean Air Act and ordered the company to outfit it with "scrubber" technology that will cost hundreds of millions of dollars.

"Maybe we're on the brink of a greater price differential between cleaner bonds in the utility base compared with more black or brown utilities," the syndicate banker said.

Duke Energy and Southern's subsidiaries Alabama Power and Georgia Power also came with new bonds in September that caused some chatter among investors for their negative credit ratings and high coal exposures.

However, subsequently those have all seen some support in secondary trading.

Despite some pushback on specific names, the environmental social and governance effect has not yet dented market conditions for utilities in a broader sense.

Average US high-grade utility spreads remain relatively tight at 118bp over Treasuries — 41bp tighter on the year, according to ICE BofA data.


The multiple fires raging across California last week, sparked by utility electrical wires, serve as another grim reminder of the vast environmental risk tied up in utility bonds.

Last year, the once Single A rated California utility Pacific Gas & Electric was plunged into bankruptcy following a string of fires it failed to prevent, and this week Southern California Edison's bonds (rated Baa3/BBB/BBB-) widened by as much as 83bp after state investigators found its equipment caused last year's Woolsey fire.

California utilities have been shutting off power in order to try and prevent wild fires, which could add further social pressure to the overall business risk of utilities operating in wildfire prone areas, Moody's wrote in a report last week.

"Each public safety power shutoff increases the likelihood of a more contentious regulatory environment, regardless of how many wildfires a successful shutoff avoids," the report reads.

"The California wildfires illustrate how considerations of environmental, social and governance risk are connected and how they affect credit," Moody's wrote.

Utilities are also under scrutiny from Democrats such as Bernie Sanders, who wants to make energy companies publicly owned, and Elizabeth Warren, who wants to place strong new regulations on the sector.


With all this volatility, utilities may no longer be the bastion of homogeneously safe credits the buyside could once count on for safe returns in times of stress.

Utilities are the most downgraded sector over the last 12 months, according to Jason Shoup, head of global credit strategy at Legal & General Investment Management America.

Not many have crossed into high-yield, but some are headed that way as 11.7% of the utility sector holds two or more negative outlooks from the ratings agencies - the third highest rate among the sectors tracked by analysts at CreditSights.

"You start to add this all up and you see this is a sector that has more idiosyncratic risk than you might have expected," Shoup said.

"It was pretty low differentiation between companies before and that's been totally turned on its head over the last year."