NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the long-term Issuer Default Rating (IDR) of OGE Energy Corp. (OGE) at 'A-' and the long-term IDR of Oklahoma Gas & Electric Company (OG&E) at 'A'. The Rating Outlook for both entities is Stable.
Approximately $2.8 billion of debt is affected by these actions. A full list of rating actions follows this release.
KEY RATING DRIVERS
OGE
Stable Utility Operations
OGE's rating and Outlook reflect the stable cash flows and earnings primarily provided by its regulated utility, Oklahoma Gas and Electric (OG&E). In 2014, OG&E's EBITDA represented approximately 77% of OGE's total EBITDA. In Fitch's view, Oklahoma, which represents 78% of OG&E's total rate base, has relatively supportive regulations. Capex pre-approvals, and riders for storm, smart grid and demand programs give the utility the opportunity to earn close to its 10.2% authorized return on equity (ROE). Oklahoma legislation allows utilities to recover environmental compliance costs to meet state and Federal mandates, which is important due to OG&E's reliance on coal generation. Federal Energy Regulatory Commission (FERC) regulations allow for recovery with minimal lag. Although its authorized ROEs in recent years are declining, they remain competitive. Arkansas regulations are considered relatively restrictive. However, the recent enactment of HB1655 shows signs of improvement.
Midstream Partnership Manages to Preserve Credit Quality
OGE's rating also reflects the operating risks at its commodity-sensitive midstream partnership, Enable Midstream Partners (Enable), as it is an important part of OGE's operating strategy and income source. At the end of 2014, OGE owned 50% of the general partnership and 26.3% of limited partnership at Enable. Fitch consolidates Enable's financials proportionally when assessing OGE's credit quality. OGE's share of Enable's EBITDA represented approximately 23% of consolidated EBITDA in 2014.
Fitch affirmed Enable's 'BBB' IDR in January 2015 despite the challenging operating environment. Enable's rating was primarily supported by its relatively low leverage, significant fee-based earnings, scale of operation and diversity of assets and customers. Fitch's primary credit concern for Enable is the commodity and volume exposure associated with its gathering and processing segment, which accounted for approximately 58% of gross margin at the end of 2014. This segment generated 59% of the gross margin from fee-based contracts in 2014, over half of which was volume dependent. Fitch believes gathering and processing volume will grow in the next few years but at a slower pace. The growth is driven primarily by crude oil and natural gas liquids drilling activities in the Williston and Anadarko basins, offset by decline in the lean-gas Ark-La-Tex and Arkoma basins which are less economic to produce at current commodity prices. The impact of the decline in these basins is partially offset by minimum volume commitment contracts. Enable has lowered the outlook for natural gas gathering and processing volume for 2015 by 14% in its latest guidance (based on midpoint guidance).
In the transportation and storage segment, 89% of the gross margin was from fee-based contracts, 7% of which is volume dependent. The earnings in the transportation and storage segment are primarily driven by producer activities around the pipeline systems and natural gas end-user demand. Some areas of the systems have contracts with higher rates than current market rates and face re-contracting risks. To protect its credit quality, Enable is expected to reduce expansion capex by approximately $375 million (based on midpoint guidance) or 30% from the previously announced plan in late 2014.
Credit Metrics Expected to Decline:
OGE's credit metrics historically have been well positioned for its rating and risk profile. For the last three years, debt-to-EBITDA averaged 3.2x and funds from operations (FFO) adjusted leverage averaged 3.4x. Going forward, incorporating the environmental capex and the expiration of bonus depreciation, the debt-to-EBITDA and FFO adjusted leverage are expected to reach 3.5x and 4.1x, respectively, in 2018 and decline to 3.2x and 3.9x by end of 2019. These ratios remain consistent with its rating category.
Oklahoma Gas and Electric (OG&E)
Constructive Regulatory Framework
OG&E's ratings and Outlook benefit from the supportive regulations in Oklahoma, its primary service territory. OG&E in some cases receives pre-approval of construction projects and has riders that support storm cost recovery and smart-grid, and a demand program rider that allows for recovery of lost revenue associated with energy and demand reduction. OG&E can recover electric fuel and gas commodity costs through a Fuel Adjustment Clause (FAC) outside of base rate proceedings. These mechanisms provide visibility of earnings and partially offset the lowered authorized ROE of 10.2% in Oklahoma in the rate case settlement in 2012. In 2014, OG&E was able to earn the authorized return. Fitch considers FERC supportive to OG&E's credit quality. While FERC-authorized ROEs have declined in recent years, they remain competitive. FERC permits construction work in progress (CWIP) recovery in rate base. OG&E has formula rates with 11.1% ROE and up to 56% equity. FERC also allows utilities to recover all construction costs if approved projects are abandoned or cancelled in part or in whole for reasons beyond their control.
In Arkansas, the enactment of HB1655 is considered a positive development in this relatively restrictive jurisdiction. The law allows utilities to apply a formula rate component with annual adjustments. Rates can be adjusted if a utility earns 50bps above or below the authorized ROE. The law provides OG&E an opportunity to earn closer to its authorized 9.95% ROE, which is low for an integrated utility relative to its peers in other states.
Stringent Environmental Mandate
OG&E's rating and Outlook take into consideration the substantial environmental compliance requirements associated with its coal-fired generation fleet. In 2014, OG&E produced 61% of energy from coal-fired generating plants. In August 2014, OG&E submitted an environmental compliance plan with the Oklahoma Corporation Commission (OCC) related to regional haze and Mercury and Air Toxics Standards (MATS). The filing follows the U.S. Supreme Court's decision to deny OG&E's petition to review a circuit court decision on regional haze regarding whether the Environmental Protection Agency (EPA) acted lawfully in rejecting portions of state of Oklahoma's plan and issuing its own plan to address regional haze. OG&E is required to comply with EPA's Federal Implementation Plan (FIP) for regional haze by January 2019 and with MATS by April 2016.
The plan includes installing dry scrubbers at Sooner Units 1 and 2 and the conversion of Muskogee Units 4 and 5 to natural gas, and modernizing the gas units at the Mustang Power Plant. OG&E estimates the total capital cost to be $1.1 billion. CWIP recovery is a preferred mechanism from a credit perspective and from a rate mitigation standpoint. An approval from the OCC is expected in the second or third quarter of 2015. OG&E will also seek related recovery from the APSC in the second quarter of 2015.
OG&E's rating stability depends on continued regulatory support for environmental capex on a timely basis. Oklahoma legislation allows utilities to recover environmental compliance costs incurred to meet both state and Federal mandates, and Arkansas permits a rider recovery for federal or state regulatory mandates.
Although Fitch believes that the required capital costs are manageable and will likely be recovered in rates, the estimated 15%-20% rate increase for residential and industrial customers could cause political backlash and impair future recoveries.
Resilient Economy
Oklahoma's unemployment rate is consistently lower than the national average. In February 2015, Oklahoma's unemployment rate was 3.9%, compared to the national average of 5.5%. Oklahoma City's unemployment rate in February was 3.6%. From 2008 to 2014, OG&E has experienced customer growth of nearly 1% per year.
Oklahoma has a diverse economy that is supported by oil/gas, aerospace, insurance, R&D and retail. The company expects to maintain nearly 1% customer growth and 1.5% load growth on a weather-normalized basis in the foreseeable future despite the slowdown in the E&P sector. OG&E's revenue mix is fairly balanced. In 2014, it generated approximately 38% of the revenue from residential customers, 24% from commercial customers, 9% from industrials, 9% from public authorities, 8% from oil field and 13% from other sources.
RATING SENSITIVITIES
OGE
Positive:
--Unlikely in the foreseeable future due to the uncertainties surrounding the environmental compliance plan and the challenging midstream business.
Negative:
--If OGE incurs substantial debt leverage to support Enable or OG&E;
--If OG&E or Enable is downgraded;
--If debt-to-EBITDA increases to 3.8x and FFO adjusted leverage increases to 4.2x on a sustained basis.
OG&E
Positive:
--Due to uncertainties surrounding the environmental compliance plan, it is unlikely that OG&E will be upgraded in the foreseeable future.
Negative:
--If the Oklahoma commission's decision on the environmental compliance plan is unfavorable such that significant disallowance or lag incurs;
--If environmental compliance projects experience material cost overrun;
--If debt-to-EBITDA increases to 3.6x and FFO adjusted leverage increases to 4x on a sustained basis.
KEY ASSUMPTIONS
--OG&E customer growth 0.8% to 1% from 2015-2019;
--$1.1 billion capex spending for the environmental compliance plan from 2015-2019;
--5% reduction in Enable LP ownership by 2019.
Fitch affirms the following ratings with a Stable Outlook:
OGE Energy Corp.
--Long-term IDR at 'A-';
--Senior unsecured debt at 'A-';
--Short-term IDR / commercial paper (CP) at 'F2'.
Oklahoma Gas & Electric Company
--Long-term IDR at 'A';
--Senior unsecured debt at 'A+';
--Short-term IDR and CP at 'F1'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014);
--'Recovery Ratings and Notching Criteria for Utilities' (Nov. 13, 2013);
--'Parent and Subsidiary Rating Linkage' (Aug. 5, 2013);
--'Rating U.S. Utilities, Power and Gas Companies' (March 9, 2014).
Applicable Criteria and Related Research:
Recovery Ratings and Notching Criteria for Utilities
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=863298
Rating U.S. Utilities, Power and Gas Companies (Sector Credit Factors)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=735155
Parent and Subsidiary Rating Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685552
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=983165
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