Fitch has placed the debt securities of Metropolitan Edison Co. (MetEd) and Pennsylvania Electric Co. (PenElec) on Rating Watch Negative. The rating action reflects the higher commodity exposure and business risk that would result from the possible termination of the existing power supply contract with wholesale power supply affiliate FirstEnergy Solutions (FES) and the increased likelihood that Pennsylvania regulators will reject the generation rate cap adjustments proposed by the utilities. The ratings of parent company FirstEnergy Corp (FE; IDR 'BBB-' by Fitch) are unaffected by the rating action. The utilities' ratings are summarized below.
On Oct. 31, 2006, the administrative law judges (ALJs) issued their recommended decision in MetEd and PenElec's pending rate case rejecting key elements of the utilities' proposed transition plan which, among other things, would have increased generation rate caps prior to the end of the utilities' transition plans on Dec. 31, 2010. Earlier this year, FES, an affiliate of MetEd and PenElec and subsidiary of FE, filed notice with the utilities of its intent to terminate their wholesale power sales agreement effective midnight Dec. 31, 2006. Subsequently, FES amended the wholesale power sales agreement requiring PenElec and MetEd to procure approximately 33% of their uncommitted provider of last resort obligation of approximately 2.8 million megawatt hours (mwh) through a request for proposal (RFP). FES retains the right to cancel the revised contract with 60 days notice. The RFP was completed in September 2006 at prices above the utilities' standard offer rate. Fitch estimates the shortfall is approximately $70 million-$100 million annually, which will pressure cash flow and credit metrics in the near term.
If the power sales contract, which supplies approximately 25%-30% of the combined loads of PenElec and MetEd at a price in the mid-$40 mwh range, were cancelled in its entirety, Fitch estimates that MetEd and PenElec's combined procurement costs would exceed the fixed price standard offer tariffs by approximately $200 million-$300 million annually in 2007 and 2008, assuming market prices of $70-$80 per mwh, with the exposure growing thereafter as other supply agreements roll off. Moreover, continuation of the rate cap in a high commodity cost environment sets the stage for significant post-transition rate increases and potential political resistance to rate hikes in 2011.
Fitch notes that the ALJs' recommendation does not bind the PUC. Nonetheless, the probability that the commission will reverse the ALJs to allow a phase-in of higher generation rates as proposed by FE is small, in Fitch's opinion. In addition, the recommended transmission and distribution rate increases for MetEd and PenElec included in the ALJs recommendation are significantly less than the amounts requested by the utilities. If the commission adopts a final order consistent with the ALJs' recommendation, credit rating downgrades are likely to follow. A final commission order is expected in January 2007.
MetEd and PenElec filed their rate case in April 2006 requesting rate increases ranging from 19%-24% and 15%- 19%, respectively, based on preferred and alternative proposals included in their comprehensive transition plan filings. Under the ALJs' recommended decision, MetEd and PenElec revenues would be increased $10.6 million and $26.4 million, respectively, compared to requested amounts of $216 million-$269 million and $157 million-$206 million.
MetEd
-- Issuer Default Rating (IDR) 'BBB-';
-- First mortgage bonds 'BBB+';
-- Senior unsecured 'BBB';
-- Short-term rating 'F3'.
PenElec
-- IDR 'BBB-';
-- First mortgage bonds 'BBB+';
-- Senior unsecured 'BBB';
-- Short-term rating 'F3'.
Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.
