Utility companies reliant on coal-fired power plants may be starting to get a cold shoulder from corporate debt investors as the risks around rapid climate change come to the fore.
If attitudes against coal energy shift in Washington D.C., the worry is electricity providers may suffer unanticipated write-downs if forced to shut down their coal plants well before their expected retirement date, turning them into so-called stranded assets on their balance sheets, according to climate-conscious money managers.
Outright restrictions on coal energy use may be less of a problem than the prospect of additional regulations that mandate coal power plants retrofit pricey equipment to reduce pollution or greenhouse gas emissions.
“The major risk down the road is not whether people are going to buy coal but that there will be additional regulation and capex requirements by a future administration,” said Steven Oh, global head of credit and fixed income for PineBridge Investments.
“I think you should probably get a premium for that to the extent that the coal industry’s demise is accelerated because of regulatory change,” said Oh.
Two powerful forces could accelerate the forced retirement of coal power stations, analysts say.
The next few years could bring a harsher regulatory climate as some Democratic party candidates for the U.S. presidency in next year’s election have railed against carbon-intensive energy sources on the campaign trail. The falling cost of natural gas has also undermined the economics of the coal industry, even more than increasingly competitive renewable sources of energy.
“The worry is that investors may start to impute a discount if someone like Elizabeth Warren comes to power,” said Michael Temple, head of corporate credit research for Amundi Pioneer.
There are signs that electricity companies are shifting away from coal. North Carolina-based Duke Energy
announced on Oct. 1 it would accelerate the schedule at which it would retire five coal-fired plants as part of its plan for a cleaner fleet of power stations.
Temple conceded electric utilities may not take much of a hit from shuttering coal plants as many of them are decades old and therefore fully depreciated, but for the ones that are not the risk could lead to credit ratings downgrades, he said.
“Some coal-fired assets may still be profitable to asset owners, have the technical potential to keep operating, and/or are not fully depreciated, so premature retirement may have significant financial consequences to asset owners,” said a 2018 paper by the Rocky Mountain Institute, an energy thinktank.
Yet most corporate bond buyers appear unperturbed by the possibility that coal power plants could become a millstone around the necks of utility firms, even though the industry’s fortunes have sagged. Murray Energy, a coal mining company, filed Chapter 11 on Monday, marking the eighth bankruptcy in the coal industry over the past year.
This broader story of corporate distress, however, hasn’t trickled down to utility providers.
Andy Devries, a senior analyst at CreditSights, said the extra borrowing costs paid by utilities reliant on coal over those that were less dependent were “zilch.”
Still, CreditSights reported signs that bond investors may not stay indifferent at least for new debt issuance as more market participants comply with environmental, social and governance criteria (ESG).
Investors said the divestment movement started to gain ground after California’s insurance commissioner in Jan. 2016 called on all insurance companies in California to stop making further investments in coal in the future.
“No one is worried about credit quality, it’s more about how people can’t own it, because they’ll look bad,” said DeVries.
The few acts of divestment have not budged the corporate bond market though. In 2018, Norway’s government pension fund sold its holdings in PacifiCorp
because more than 54% of its total power generation came from coal last year. Yet, the yield for the bond traded only a few basis points away from the bonds of similarly rated utility firms.
PacifiCorp’s $850 million of bonds due in April 2029 traded at an average of 109 cents on the dollar on Tuesday, up around 9% since the debt was sold this January, according to bond trading platform MarketAxess.
The bonds also traded at a spread of 65 basis points to equivalent U.S. Treasurys, compared with 95 basis points in Jan. 7. A narrower credit spread can indicate when investors see diminished risk around buying a corporate bond.
Still, some ESG-compliant investors are pessimistic about coal’s future amid worries that regulators may force the pace as utility companies move slowly to less carbon-intensive forms of energy, inflicting higher power prices on consumers also.
However, “regulators aren’t going to want to create a situation where they force change at such a pace that customers wind up losing access to electricity. It’s politically dangerous,” said Tom Graff, head of fixed income at Brown Advisory, which runs a sustainable investing bond fund.
Even if investors aren’t getting paid to avoid coal-heavy companies now, that doesn’t mean they shouldn’t act preemptively, he said. Steering clear of such firms was an act of prudent risk management, where investors could avoid “more remediation costs, more retrofitting costs, paying more of a carbon tax, etc,” without having to give up additional yield.
“If companies are trading at roughly similar yield, why wouldn’t you want one that’s better positioned for a low-carbon future?” asked Graff.