Fitch: EPA's CPP Holds Mixed Impact for the US Power Sector

NEW YORK--()--The final Clean Power Plan (CPP) unveiled Monday by the Environment Protection Agency (EPA) appears less onerous for the U.S. power sector versus the draft rule released in 2014, according to Fitch Ratings. The final rule offers some concessions to states to meet the updated carbon emission goals, but it will nonetheless be a challenge for the U.S. power sector.

The final rule provides states more time than initially proposed to comply, which should somewhat assuage a key concern voiced by utility managements. States now have until 2018 to submit their compliance plans to the EPA and until 2022 (rather than 2020) before they have to start meeting the interim emission goals. Nevertheless, compliance with the CPP will require significant infrastructure investment in building out renewable power generation and associated transmission networks as well as investments in natural gas pipeline infrastructure to facilitate coal to gas switching. Given the long lead times required to plan and build these assets, we believe compliance by 2022 could still be a challenge for some states.

The final rule makes key changes to the options available to the states to cut carbon emissions or the four "building blocks" identified in the draft rule. Some of the refinements to the building blocks in the final rule are positive for the industry. The removal of energy efficiency as a building block, a lower projected improvement in efficiency of existing coal plants (range of 2.1%-4.3% versus 6% in the draft rule), and exclusion of existing nuclear or under-construction nuclear or existing utility-scale renewable energy generation should appeal to the states and ease the path to compliance.

Alternatively, building block 2 assumes that natural gas plants can run up to 75% of the net summer capacity versus 70% of the nameplate capacity in the draft rule forcing less reliance on coal-to-gas switching during the initial years to drive emission reductions. Furthermore, building block 3 anticipates more use of renewable energy, and the EPA is targeting share of renewable generation to increase to 21% in 2030, which appears aggressive.

The final CPP includes provisions for reliability assurance to address the pushback received from the industry that excessive shutdowns of coal capacity have the potential to impede grid reliability. It requires the states to incorporate the reliability impact of their implementation plans, allows the states to seek revisions to their implementation plans if unanticipated or significant reliability issues arise, and provides for a "reliability safety valve" to keep reliability critical generation online outside the constraints of carbon emissions. The EPA acknowledges that the Department of Energy and the Federal Energy Regulatory Commission will have to monitor the implementation of the final CPP and assess its impact on reliability.

The final rule mandates a 32% cut in carbon emissions by 2030 from 2005 levels, which is a more aggressive target than the 30% cut proposed in the draft rule. Similar to the draft rule, the final CPP mandates a different emission reduction target for each state. However, the EPA has refined its approach by first applying the building blocks to the three established regional interconnects. The EPA advocates a multistate, market-based approach, such as emissions trading, as a cost effective way to achieve compliance.

We believe the final CPP rule will be litigated. The judicial review process, along with the shifts in the political landscape (given the state implementation plans will be finalized under the next administration), could drive the timing and severity of the CPP implementation.

The CPP has far-reaching implications in terms of how electricity is produced and consumed and is likely to result in upward pressure on capital expenditures plans, O&M expense and electricity rates. The cost of compliance will be materially influenced by the states' decision to go alone or deploy multistate approaches to reduce carbon emissions.

Within the regulated universe, the utilities with coal dominant portfolios could see the most adverse impact, since increased cost of compliance would ultimately flow through to consumers as higher rates for electricity. However, those utilities with constructive regulatory regimes, ability to recover federally mandated environmental costs either through riders or pre-approval of environmental capex, and a manageable glide path for rate increases could ultimately benefit through higher rate based growth, in Fitch's view. Among the non-regulated power generators, Fitch expects companies with cleaner portfolios, such as Exelon, Nextera Energy Inc., and Calpine, to be beneficiaries of the CPP.

Additional information is available on www.fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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Contacts

Fitch Ratings
Shalini Mahajan, CFA
U.S. Corporates - Utilities, Gas and Power
Fitch Ratings
+1 212-908-0351
33 Whitehall Street
New York, NY
or
Kellie Geressy-Nilsen
Senior Director
Fitch Wire
+1 212-908-9123
or
Media Relations
Sandro Scenga, New York, +1 212-908-0278
sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Shalini Mahajan, CFA
U.S. Corporates - Utilities, Gas and Power
Fitch Ratings
+1 212-908-0351
33 Whitehall Street
New York, NY
or
Kellie Geressy-Nilsen
Senior Director
Fitch Wire
+1 212-908-9123
or
Media Relations
Sandro Scenga, New York, +1 212-908-0278
sandro.scenga@fitchratings.com