Moody's: Policy and regulatory credit risks emerge for global regulated utilities amid decarbonization efforts

Global regulated electric and gas utilities and regulated networks are a major focus of carbon transition policies and face rising credit risks from decarbonization initiatives, Moody's Investors Service says in a new report. The sector is central to countries achieving nationally determined contributions (NDCs) under the Paris Agreement, since power generation is a top contributor of carbon emissions.

"From a credit perspective, utilities are increasingly exposed to carbon transition risks because there are large costs to converting infrastructure to a more environmentally friendly and flexible generation mix," says Natividad Martel, a vice president at Moody's.

The utility sector is a focus of decarbonization efforts because it is also the primary source of carbon-free energy via renewables, nuclear and hydro power. Additionally, decarbonizing the broader economy usually implies electrification of sectors such as transportation and heat, which creates growth opportunities for the utility sector.

Moody's assesses carbon transition risk using its central emissions scenario consistent with the NDCs agreed to as part of the Paris Agreement. The credit rating agency has developed a framework to evaluate the credit impact on all sectors under three transmission mechanisms: policy or regulatory uncertainty, demand substitution or changes in consumer preferences, and risk of technological shocks.

For regulated utilities, the regulatory framework is the fundamental driver of credit quality since it allows the recovery of all operating costs plus a return on investments. How regulators will support recovery of most or all costs related to carbon transition will be a critical determinant of the credit impact of carbon transition.

Stranded assets are a key concern for utilities, as well as affordability if tariff increases are significant. However, business mix is the chief driver of carbon exposure utilities face, and utilities that own generation assets have substantially more carbon risk than those that do not.

"Among generation-owning utilities, fuel mix is a major determinant of carbon exposure," says Martel. "In some smaller countries like Costa Rica and Uruguay, the power sector is largely decarbonized, while countries such as in China, India, South Africa and Indonesia have a significant share of coal generation."

Beyond coal, over the long-term, natural gas plants may also come under pressure as countries increase their renewable energy targets and battery technology becomes more affordable. Currently, eight US states have renewable energy goals of at least 80% by 2050.

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