Moody’s gives US utility issuers a transition risk wake-up call

40% of U.S. power generators are poorly positioned for a transition to a low-carbon economy because their business plans rely on coal and natural gas through 2025, according to a new framework that Moody’s Investors Service is applying to arrive at carbon transition assessment (CTA) scores for rated U.S. utility issuers.

This is important because the credit rating agency’s new CTA scores will inform Moody’s analysts, bankers and investors’ thinking about the risks and opportunities that will shape the revenues, costs and capital deployment in the U.S. power sector.

How a CTA score will affect a utility borrower’s cost of capital will be for the market to decide, but Moody’s sees carbon transition risk as a material element to consider.

“Company strategy for the energy transition is fundamental to assessing creditworthiness,” said James Leaton, senior vice president in Moody’s ESG Group in London and author of the report that introduces Moody’s approach to assessing the carbon transition risks of U.S. utility and power generation issuers.

“Our framework is a way to be more transparent about the way that we are approaching [transition risks],” Leaton said. Moody’s new CTA scores were designed to align with its environmental, social and governance (ESG) metrics, and both datasets will feed into its credit ratings analysis. For bankers and investors, who have been grappling with carbon transition risk, the CTA scores offer another way to differentiate between companies.

Utilities recognize that transition risk is a key risk for their sector, but they also need to see the opportunities that it presents, Leaton said. Solar and other renewable assets get the best scores for alignment with a carbon transition, but other factors, including a utility’s state-level regulatory environment and its business diversification, can also help lower a utility’s CTA score, he added. In its report, Moody’s noted that utility issuers with operations that included non-generation activities tended to have lower CTA scores; for this reason, Moody’s calculated separate scores for non-generation activities.

According to Leaton, the poor positioning of some utilities reflects Moody’s view that coal generation will represent only 10% of the U.S. generation mix by 2030. However, the general power decarbonization trend that is currently underway looks set to accelerate when President-elect Biden takes office because his platform has included focusing on decarbonization, he added.

Yesterday, in a report outlining its new approach to assessing sovereign climate risk, Moody’s affiliate Four Twenty Seven noted that transition risk also affects sovereign climate risk. “Countries with high fossil fuel consumption that lack renewable energy will be exposed to increasing energy costs as policies shift,” the report said. “Understanding sovereign transition risk alongside physical risk exposure provides a more complete picture of risk,” it added.