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Fitch: Balanced Regulation Supports California Utility Ratings

NEW YORK--(BUSINESS WIRE)--The balanced regulatory compact in California remains a key factor supporting the credit ratings of investor-owned utilities (IOU) in the state, amid nascent secular challenges, according to Fitch Ratings.

California tends to lead and is often at the cutting edge of changes in the utilities sector (as in the case with deregulation in the 1990s). The state is again at the forefront in implementing energy policy to reduce carbon emissions.

Fitch expects a balanced regulatory compact will persist in the near-to-intermediate term, notwithstanding uncertainties regarding rate design, alternative generation, energy efficiency, high electric rates and pending investigations into Pacific Gas & Electric Co.'s (PG&E) natural gas business.

Political rancor and inability to conclude the California Public Utilities Commission (CPUC) order instituting investigations (OII) into PG&E's role in the San Bruno pipeline explosion and fire are continuing sources of uncertainty for investors. PG&E has incurred significant unrecoverable costs in the wake of the incident and the utility's earned returns remain well-below authorized levels.

Investors have expressed concern that the magnitude of the proposed OII penalties, on top of San Bruno-related costs already absorbed by PG&E, signals deterioration in the broader regulatory compact in California. This uncertainty is not helped by the significant reductions in authorized returns on equity in CPUC's last cost-of-capital (CoC) proceeding and delays adjudicating general rate cases in recent years.

We believe that the following factors represent significant long-term potential secular challenges to utility creditworthiness: high and rising kilowatt hour rates; large capex requirements; increasing energy efficiency among customers; and strong state and federal support for distributed generation and microgrid development.

Notwithstanding these concerns, Fitch remains of the opinion that the regulatory compact in the state is balanced from a credit point of view and that the CPUC continues to believe that strong IOU creditworthiness is in the best interest of both ratepayers and investors. IOU creditworthiness in the near to intermediate term is supported by robust regulatory mechanisms that effectively ameliorate rate lag and provide a reasonable opportunity for California-based IOUs to earn their authorized returns. Despite reductions mandated in 2012, ROEs authorized by the CPUC remain above the US industry average. We believe CPUC efforts currently underway to revamp residential rate design and create new net energy metering programs are a constructive credit development.

CPUC general rate case decisions during the pendency of its San Bruno rulemakings and investigations have, in our opinion, continued to demonstrate the balanced regulatory compact (including PG&E's recent 2014 final CPUC decision). We expect that large California IOUs will continue to report returns on equity consistent with authorized levels in the near to intermediate term, with the exception of PG&E. Fitch believes that PG&E's returns will begin to normalize at higher levels following the conclusion of the CPUC's investigation into the utility's role in the September 2010 pipeline explosion.

Adverse changes to the California regulatory compact would likely lead to future credit rating downgrades.

For more information, please see Fitch's report published today, "California Regulation: Balancing Act," available on www.fitchratings.com.

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.

Applicable Criteria and Related Research: California Regulation: Balancing Act

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=758267

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