Overview
— The merger between U.S. utility companies Duke Energy Corp.
and Progress Energy Inc. was completed on July 2, 2012.
— We are placing our ‘A-‘ corporate credit on Duke Energy and its
subsidiaries on CreditWatch with negative implications in response to the
abrupt change in executive leadership disclosed after the merger with Progress
Energy. We are also placing the issue ratings on Duke Energy and its
subsidiaries on CreditWatch negative.
— We are revising the CreditWatch implications on our ‘BBB+’ corporate
credit rating on Progress Energy and its subsidiaries to developing from
positive. We are also revising the CreditWatch implications on the companies’
issue ratings to developing from positive.
— The CreditWatch listings reflect unresolved issues on corporate
governance, merger integration execution, and management of pending
operational challenges.
— We are evaluating whether the combined entity warrants an “excellent”
business risk profile under our criteria in light of potential integration
challenges and corporate governance issues.
Rating Action
On July 3, 2012, Standard & Poor’s Ratings Services placed its ‘A-‘ corporate
credit rating on Duke Energy and all its subsidiaries, Duke Energy Carolinas
LLC, Duke Energy Indiana Inc., Duke Energy Kentucky Inc., and Duke Energy Ohio
Inc., on CreditWatch with negative implications. The issue ratings on Duke
Energy and its subsidiaries are also placed on CreditWatch with negative
implications.
In addition, we are revising the CreditWatch implications on our ‘BBB+’
corporate credit rating on Progress Energy and its subsidiaries, Carolina
Power & Light Co. d/b/a Progress Energy Carolinas Inc. (PEC) and Florida Power
Corp. d/b/a Progress Energy Florida Inc. (PEF), to developing from positive.
The CreditWatch placement of the issue ratings on Progress Energy and its
subsidiaries is also revised to developing from positive. The ratings were
initially placed on CreditWatch on Jan. 10, 2011.
Rationale
The rating actions are based on the change in the position of chief executive
officer immediately upon the close of the merger between Duke Energy and
Progress Energy.
The sudden shift in management raises concerns about effective corporate
governance, successful handling of the anticipated merger integration, and the
ongoing effective management of pending challenges that face the combined
entity.
Immediately upon the close of the merger between Duke Energy and Progress
Energy, the new board of the combined entity voted to appoint Jim Rogers as
chief executive officer effective immediately. He will also maintain his
previous position as chairman of the board. Bill Johnson, who was expected to
become the chief executive officer of the merged entity, resigned.
Standard & Poor’s expects to resolve the CreditWatch listing in the near term
after a closer review and assessment of the implications of the change in
leadership and its impact on the combined entity.
Duke Energy’s large and diverse U.S. regulated utility operations serve more
than 7 million customers in the Carolinas, the Midwest, and Florida. The
utilities operate under generally credit-supportive regulatory environments
that provide for slightly below-average returns and timely recovery of fuel
and other variable costs. The utility operations benefit from operating
diversity in six states, and demographic and economic diversity in service
territories that range from average to attractive. Duke Energy’s generation
operations have high availability and capacity utilization factors and rates
are competitive for the regions of operations providing some cushion for
future rate increases and fuel cost recoveries. These strengths are offset by
a significant capital spending program that will total between $6 billion and
$6.5 billion per year through 2015, with almost 90% of that targeted for
regulated utility projects. The capital spending program is large, will
necessitate additional debt issuance to fund, and will require regular
base-rate increases to incorporate the new-generation assets into rate base.
As a result, ongoing effective management of regulatory risk that produces
improving regulatory returns will be very important to support credit quality.
Supportive rate settlements in North Carolina and South Carolina in 2011
established a constructive beginning to Duke’s multiyear effort to place
several large generating stations in rate base in those states.
Duke Energy Ohio’s latest electric security plan (ESP) went into effect in
January 2012 and expires in May 2015. Customer and margin losses experienced
under the previous ESP due to greater competition and low market prices for
generation in Ohio had eroded financial results and resulted in higher
business risk in the state. The new ESP is notable for finally and formally
accomplishing what the 1999 deregulation law envisioned: energy from much of
Duke’s electric generating plants in Ohio is now priced at market through a
competitive bidding process. The ESP plan also alters the non-bypassable
charges customers will bear, including a new capacity charge for Duke Energy’s
legacy rate-based generation in the state that equates to a cost-of-service
type of return on embedded and future investment. In combination with some
profit-sharing components of the ESP that allocate additional legacy
generation value to customers, Duke has managed to restore its ability to earn
a stable and fair return on the bulk of its Ohio assets at least through 2015.
The Midwest gas-fired assets that were never regulated now have a completely
market-based orientation.
Cost increases in Indiana related to the construction of the 630 megawatt (MW)
Edwardsport integrated gasification combined cycle coal plant resulted in a
settlement with various intervenors that caps the total cost of the project at
$2.6 billion, causing an additional impairment of about $450 million in the
first quarter of 2012 to the $266 million impairment incurred in late 2011. If
the Indiana Utility Regulatory Commission approves the settlement, the
uncertainty surrounding the company’s cost recovery for the plant would be
mitigated, leaving the company to demonstrate satisfactory operation of the
plant once online. We expect the company will address the effect of the
impairment on Duke Energy Indiana’s balance sheet in a credit-supportive
manner.
Progress Energy Florida’s biggest challenge over the next few years will be to
resolve questions surrounding the Crystal River 3 nuclear plant, which has
been off-line since 2009 due to problems with the concrete used in the
containment structure. PEF proposed to repair the unit instead of retiring it,
a process that could take until 2014 to complete at a cost estimate of $900
million to $1.3 billion. Repairs that change the original licensing basis of
the unit could require the Nuclear Regulatory Commission’s approval. In
February 2012, the Florida Public Service Commission (FPSC) approved a
settlement agreement between PEF and various intervenors that provides PEF
with an effective framework to make prudent decisions regarding Crystal River
3.
Standard & Poor’s ascribes higher business risk to Duke’s international
operations due to the uncertainty of the local political and regulatory
environments in the countries where it operates: Argentina, Brazil, Peru, and
Saudi Arabia. The Latin American assets have been self-funding, and we
discount cash flow from overseas in our analysis of Duke’s ability to service
the U.S. rated debt. Any substantial capital spending at the international
operations could have negative ratings implications, depending on the risk
profile of the spending. Duke is also planning to increase its renewable
generation business which we expect it will finance in a credit-neutral manner
and under a model that minimizes market risk through long-term contracts with
suitable counterparties. Any substantial acceleration in the growth of this
segment could also negatively affect ratings.
Duke’s consolidated financial risk profile is “significant” under our
criteria. Historical credit metrics have been steady despite large capital
projects, in part reflecting low debt leverage, and we expect the financial
profile to remain stable over the intermediate term benefiting from
merger-related cost savings and timely recovery of the investment through
regular rate-case filings. We expect adjusted debt leverage to be about 50%,
with adjusted FFO to total debt ranging from 18% to 20%, both of which support
current ratings.
Liquidity
The short-term rating on Duke Energy is ‘A-2’ and largely reflects the
company’s long-term corporate credit rating and the stable regulated utility
operations that generate the bulk of cash flows. Duke’s ability to absorb
high-impact, low-probability events with limited need for refinancing, its
flexibility to lower capital spending or sell assets, its sound bank
relationships, its solid standing in credit markets, and generally prudent
risk management further support our description of liquidity as “adequate”
under our criteria.
Duke manages the liquidity needs of all its subsidiaries. We assess its
liquidity as adequate based on the following factors and assumptions:
— We expect the company’s liquidity sources (including FFO, and credit
facility availability) over the next 12 months to exceed its uses by more than
1.2x. Debt maturities over the next year are manageable.
— Even if EBITDA declines by 20%, we believe net sources will be well in
excess of liquidity requirements.
— The company has good relationships with its banks, in our assessment,
and has a good standing in the credit markets.
The companies have a total of about $6 billion in credit facilities expiring
in November 2016; $2 billion of that amount became available upon the close of
the merger with Progress Energy. The master credit facility contains sublimits
of $1.75 billion for Duke Energy, $1.25 billion for Duke Energy Carolinas,
$650 million for Duke Energy Ohio, $750 million for Duke Energy Indiana, $100
million for Duke Energy Kentucky, $750 million for Progress Energy Carolinas,
and $750 million for Progress Energy Florida. Maturing long-term debt in the
next 12 months totals about $1.8 billion after accounting for debt already
refinanced in 2012.
In our analysis, based on information available as of Dec. 31, 2011, as
updated for the new facility, we assumed liquidity of about $14.4 billion over
the next 12 months, consisting of FFO and availability under the credit
facility. We estimate the company could use up to $10.5 billion during the
same period for capital spending, debt maturities, and shareholder dividends.
Duke’s credit agreement includes a financial covenant requiring a maximum
consolidated debt-to-capitalization ratio of 65% for each borrower. All were
compliant as of March 31, 2012.
CreditWatch
Standard & Poor’s expects to resolve the CreditWatch listing in the near term
after a closer review and assessment of the implications of the change in
leadership and its impact on the combined entity.
Related Criteria And Research
— Standard & Poor’s Standardizes Liquidity Descriptors For Global
Corporate Issuers, July 2, 2010
— Standard & Poor’s Updates Its U.S. Utility Regulatory Assessments,
March 12, 2010
— Business Risk/Financial Risk Matrix Expanded, May 27, 2009
— Analytical Methodology, April 15, 2008
Ratings List
Ratings Affirmed; CreditWatch/Outlook Action
To From
Duke Energy Corp.
Duke Energy Ohio Inc.
Duke Energy Indiana Inc.
Duke Energy Carolinas LLC
Cinergy Corp.
Corporate Credit Rating A-/Watch Neg/A-2 A-/Stable/A-2
Duke Energy Kentucky Inc.
Corporate Credit Rating A-/Watch Neg/– A-/Stable/–
Duke Energy Corp.
Senior Unsecured BBB+/Watch Neg BBB+
Commercial Paper A-2/Watch Neg A-2
Cinergy Corp.
Preferred Stock BBB/Watch Neg BBB
Commercial Paper A-2/Watch Neg A-2
Duke Energy Carolinas LLC
Senior Secured A/Watch Neg A
Senior Unsecured A-/Watch Neg A-
Duke Energy Indiana Inc.
Senior Secured A/Watch Neg A
Senior Unsecured A-/Watch Neg A-
Duke Energy Kentucky Inc.
Senior Unsecured A-/Watch Neg A-
Duke Energy Ohio Inc.
Senior Secured A/Watch Neg A
Senior Unsecured A-/Watch Neg A-
CreditWatch Implications Revised To Developing From Positive
To From
Progress Energy Inc.
Corporate Credit Rating BBB+/Watch Dev/A-2 BBB+/Watch Pos/A-2
Carolina Power & Light Co. d/b/a Progress Energy Carolinas Inc. dba Progress
Energy Carolinas Inc.
Corporate Credit Rating BBB+/Watch Dev/A-2 BBB+/Watch Pos/A-2
Florida Power Corp. dba Progress Energy Florida Inc.
Corporate Credit Rating BBB+/Watch Dev/A-2 BBB+/Watch Pos/A-2
