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Emerging market utilities: The track ahead
Eugene Korovin, an associate director at Standard & Poor's Ratings Services, discusses the challenges facing EEMEA utilities in the short-to-medium term.
Since October 2007, the overall rating performance of utilities within the emerging markets has been positive. Currently, 14 of the 22 utilities in Standard & Poor's Eastern Europe, Middle East, and Africa (EEMEA) portfolio have achieved the investment grade rating of ‘BBB-' or above, including the four rated utilities in the Middle Eastern region.
Within this period there have been four upgrades across the sector and no downgrades. Furthermore, in three of the four upgrades, the relevant utility company was raised from speculative to investment grade.
Nevertheless, there are still significant challenges being faced by a number of companies in our portfolio, which may put pressure on the ratings in the short to medium term. Indeed, since October 2007, there have been several downward outlook revisions and CreditWatch placements with negative implications, which tilt the overall balance of rating outlooks to negative.
Current challenges
Certainly, the weakening macroeconomic environment in many countries of the region presents short-term challenges to credit quality. In fact, Saudi Arabia and Oman are the only host countries for our EEMEA utilities portfolio that we do not expect to suffer a slowing of GDP growth rate as a consequence of the slowdown in economic growth and mounting inflation.
Indeed, if macroeconomic environments deteriorate further, these rated companies could potentially face more painful developments, such as additional sharp increases in input cost inflation and weakening demand, as well as devaluation of the national currency, worsening payment collections and stronger regulatory pressure on tariffs driven by social and inflationary concerns.
In particular, the state-owned utilities most exposed to macroeconomic changes are those operating in Eastern Europe: Estonia, Kazakhstan, Lithuania, and Romania, which have negative outlooks for sovereign credit quality.
Indeed, state-owned utilities relying on support from the respective governments - for example, Kazakhstan Electricity Grid Operating Co. (JSC) (KEGOC) and KazTransGas - face the additional risk of shrinking sovereign support, as the ability to provide support may weaken commensurate with the national government's weakening credit quality.
Sovereign support
Meanwhile, the ratings on Saudi Electric Co. (SEC) reflect the company's continuing key role in the Saudi economy and the intention of the Kingdom of Saudi Arabia (AA-/Stable/A-1+) to remain supportive of SEC's credit quality.
The ratings also benefit from a strong forecast growth in electricity demand, as well as SEC's quasi-monopoly position in electricity generation and its monopoly position in electricity transmission and distribution services, with limited or no expected competition in the medium term.
We at Standard & Poor's analyse SEC using our criteria for government-related entities and view the company as a public-policy entity that benefits from implicit and explicit state support - albeit without an explicit financial guarantee.
Furthermore, SEC's tariff policy is effectively determined by the state, as the government is working toward a total solution for the power sector, with possible tariff rebalancing to accommodate the increased capital expenditure commitments dictated to SEC.
We also expect the government to continue to provide financial support to strengthen the company's balance sheet, which would better enable SEC to raise funding in the capital markets to support its capital expenditure programme in the future.
These credit strengths are offset by SEC's high commitments under its capital expenditure programme, which is expected to result in a deterioration of debt coverage ratios, as well as uncertainty about the company's sources of funding and regulatory risk affecting its three key business segments. In addition, SEC currently struggles to maintain a peak load capacity margin as demonstrated by brownouts.
Medium- to long-term plans, however, should ensure adequate capacity margins as long as its capital expenditure program progresses successfully.
Meanwhile, in the case of Oman Power and Water Procurement Co. SOAC (OPWP), the Sultanate of Oman's sole bulk buyer and seller of electricity and desalinated water, the government is required by law to maintain 100% ownership of the company, and to fund its operations.
However, while the company enjoys strong credit metrics, with all revenues regulated under a cost-plus tariff that allows full pass-through of procurement costs under normal circumstances, OPWP operates within a relatively untested regulatory framework and, as Oman's supply companies are privatised, counterparty risk increases.
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