MOODY'S VIEWS GENERATING ASSET SWAP AS NEUTRAL FOR FIRSTENERGY
Moody's Investors Service announced that it is maintaining a stable outlook on the ratings of FirstEnergy's utility subsidiaries, Ohio Edison, Cleveland Electric Illuminating, Toledo Edison, and Pennsylvania Power, after the company announced the signing of an agreement in principal for a largely tax-free exchange of generating assets with Duquesne Light. Moody's regards the asset swap as currently contemplated as neutral for FirstEnergy and its affiliates from a credit perspective. FirstEnergy will acquire 1,436 megawatts of generating capacity, including 662 mw of nuclear generation, from Duquesne Light Company in exchange for 1,298 mw of coal-fired capacity. Completion of the transaction would not occur until 1999 at the earliest pending four events: approval by the Pennsylvania Public Utility Commission; resolution of legal issues surrounding the termination of the merger agreement between Duquesne's parent, DQE, and Allegheny Energy; Duquesne's completion of its auction of fossil-fueled generating assets; and the unwinding of the operating lease on Duquesne's share of Beaver Valley Unit 2. Duquesne and FirstEnergy intend to sign a definitive agreement governing the exchange by December 21 of this year.
A number of benefits offset the additional nuclear operating risk being assumed by FirstEnergy, whose proportion of nuclear generation in its total generating portfolio would increase from 26% to 31%. First, it would gain operating control over all its nuclear plant investments, with positive implications for cost management. Absent the exchange, FirstEnergy would be majority owner of two nuclear units operated by a utility that is shrinking its role in the regulated electric generation sector. Duquesne, operator of Beaver Valley Units 1 and 2, is divesting all its regulated generating assets. Second, control over a larger portfolio of nuclear generating assets makes FirstEnergy a more attractive employment opportunity in an industry where nuclear management skills are of growing importance and will be in shorter supply.
Although lack of high-level nuclear waste storage capacity continues to plague the industry, nuclear power is an environmentally cleaner technology than coal, which is FirstEnergy's primary fuel source. The region's coal plants continue to be a target for tightened emissions standards.
FirstEnergy is also not increasing its debt load or potentially stranded costs with this transaction. Its utility subsidiaries would be acquiring the assets at a low book value per kilowatt of capacity. The change in tax policies necessary to implementation of full choice in Ohio would also result in a reduction in the nuclear units' production costs to levels close to the fossil plants, making them very competitive base load plants if operated at above average capacity factors.
The most important credit influence on the ratings of the FirstEnergy utilities is progress towards restructuring legislation in Ohio. FirstEnergy implemented substantial measures to mitigate its costly investment in nuclear plants which went into service in the 1980s. Cleveland Electric and Toledo Edison are particularly vulnerable to increased competition in the electric sector due to their high leverage, and legislation imposing full customer choice of generating supplier is likely in the 1999 session. Cleveland and Toledo's senior secured ratings are Ba1, whereas Ohio Edison and Penn Power, which have been able to mitigate much of their exposure or have been granted substantial recovery of this investment, have Baa2 senior secured ratings.
The exchange has positive implications for Duquesne, whose ratings (senior secured Baa1) are already under review for possible upgrade. Closing of this transaction would result in the utility's completely exiting the generation business including nuclear generation, which to date has been difficult due to depressed values on nuclear assets and uncertainty surrounding recovery of investment and waste storage. The one significant cost to this strategic initiative is the termination of the operating lease that finances its share of Beaver Valley Unit 2, a condition to closing. Duquesne expects to recover the costs related to the lease termination through the sale of the coal plants. FirstEnergy has guaranteed a floor amount for the sale proceeds, and recent sales indicate that proceeds could reasonably be expected to exceed the floor amount. As part of the termination process, Duquesne's secured lease obligation bonds would be collapsed into the utility's capital structure as unsecured debentures.
FirstEnergy is headquartered in Akron, Ohio. Its utilities serve customers in northern Ohio and western Pennsylvania. Duquesne Light serves customers and is headquartered in Pittsburgh.
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