MOODY'S ASSIGNS P-2 RATING TO ALLEGHENY ENERGY SUPPLY $400 MILLION CP PROGRAM
Moody's Investors Service assigned a P-2 rating to the new $400 million commercial paper program being established by Allegheny Energy Supply Company (AE Supply), a subsidiary of Allegheny Energy, Inc. (Allegheny). AE Supply is engaged in unregulated energy generation and trading and owns a portfolio of primarily coal-fired generating plants. Alternate liquidity for the commercial paper program will be provided by committed lines of credit from a group of banks.
Moody's also assigned a Baa1 issuer rating to AE Supply. An issuer rating is an unsecured rating intended to describe the legal entity's general credit profile as an unsecured creditor, for example as a counterparty in energy trading. It does not reflect any other structural aspects that might be expected in a specific security issuance, such as covenants or representations and warranties, which often provide additional protections to investors against event risk. Moody's believes the conservative style of the present management somewhat mitigates event risk. AE Supply was evaluated on a stand-alone basis, without support from its parent.
The Baa1 issuer rating reflects the low marginal operating cost of the largely coal-fired portfolio and its low debt burden. Debt service coverage ratios and discount-to-break-even ratios are strong over the coming years. The four largest plants comprise about 80% of total capacity. Three of the five largest plants are also scrubbed, eliminating sulfur dioxide emissions from those plants. Moody's and the company expect that the plants will require further expenditures to meet tightening environmental compliance standards, and the rating is based on assumptions that AE Supply will be able to fully comply with tough standards, although the level and timing of actual standards remain uncertain. Allegheny has not been subject to the recently-announced US Environmental Protection Agency actions against certain coal-fired plants alleged to have violated the Clean Air Act.
Allegheny Energy Supply was established by Allegheny in November 1999 to own its generating assets that are not subject to regulation and to manage the company's energy trading operations. Allegheny has engaged in modest levels of energy trading for several years as unregulated wholesale electricity trading opportunities grew and retail (end-user) trading opportunities were introduced in Pennsylvania and neighboring states. Two-thirds of Pennsylvania's electric customers could choose their electric supplier at the beginning of 1999, and all electric customers in that state now have the ability to choose generation suppliers. Allegheny's Maryland electric customers will have the ability to choose by mid-2000.
AE Supply's portfolio of unregulated generation assets will grow over time. The primary driver in the portfolio's size is the deregulation of retail electric sectors in states the company serves. As customers are granted the ability to choose their electricity supplier in each state and generating assets become unregulated, Allegheny is transferring the generating assets subject to that state's jurisdiction to AE Supply. Allegheny reached agreements in Pennsylvania and Maryland that allowed the transfer of these assets at book value. The 3,778 megawatts formerly owned by affiliate utility West Penn Power are now owned and operated by AE Supply along with an already unregulated 276 megawatt share of the Fort Martin plant. The 1,300 megawatt Maryland portion of Potomac Edison's generating assets will be transferred in the third quarter of this year. The rating anticipates Allegheny reaching similar agreements in Virginia and Ohio, where restructuring legislation is in place, but details of the transition are still being negotiated. Key parties in West Virginia reached a settlement governing the details of how the transition should proceed, and legislation is now on the floor of the House, increasing the likelihood of restructuring legislation being passed by the end of the 2000 legislative session in mid-March. Combined with a modest number of planned new gas-fired peaking and mid-merit plants, the AE Supply generating portfolio should reach 8,875 megawatts within a few years.
AE Supply will sell primarily into the southern ECAR (East Central Area Reliability) market, a very broad market that includes Ohio, western Pennsylvania, West Virginia, and Indiana. The western PJM (Pennsylvania, New Jersey, and Maryland) market is also important to its success, along with opportunities in neighboring regions. AE Supply's plants are well connected to these regions through the Allegheny transmission system. The well developed transmission system in the region also reduces the risk of overbuild in ECAR.
The unregulated portfolio will be subject to merchant plant risk, selling into electric commodity markets at market-based prices. Electricity is the most volatile commodity traded, and the generating assets' long lives compound that risk. Merchant risk faced by AE Supply is mitigated over the intermediate term by contracts with large industrial and municipal customers and by full requirements contracts with Allegheny's affiliated distribution utilities that should provide a steady and predictable revenue stream.
The rating was assigned without the benefit of an independent engineer's report, which would have given additional comfort regarding the forecasts provided by the company. However, the assumptions were subjected to additional stresses and due diligence to address this issue.
Allegheny Energy is an electric holding company registered under the Public Utility Holding Company Act of 1935. Its headquarters are in Hagerstown, Maryland. Allegheny Energy Supply is headquartered in Greensburg, Pennsylvania.
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