Credit Opinion: Duke Energy Corporation Global Credit Research - 21 Mar 2014 Charlotte, North Carolina, United States Ratings Category Moody's Rating Outlook Stable Issuer Rating A3 Sr Unsec Bank Credit Facility A3 Senior Unsecured A3 Jr Subordinate Baa1 Commercial Paper P-2 Duke Energy Carolinas, LLC Outlook Stable Issuer Rating First Mortgage Bonds A1 Aa2 Senior Secured MTN (P)Aa2 Senior Unsecured Subordinate Shelf A1 (P)A2 Duke Energy Progress, Inc. Outlook Issuer Rating Stable A1 First Mortgage Bonds Senior Secured Shelf Aa2 (P)Aa2 Senior Unsecured Shelf (P)A1 Subordinate Shelf Pref. Shelf (P)A2 (P)A3 Contacts Analyst Phone Michael G. Haggarty/New York City 212.553.7172 William L. Hess/New York City 212.553.3837 Key Indicators [1]Duke Energy Corporation 12/31/2009 12/31/2010 12/31/2011 12/31/2012 12/31/2013 CFO pre-wc + Interest / Interest 5.2x 4.8x 4.7x 4.5x 4.8x CFO pre-wc / Debt 22.5% 20.9% 18.0% 13.4% 16.7% CFO pre-wc - Dividends / Debt 15.8% 14.2% 11.8% 9.0% 11.2% Debt / Capitalization 40.4% 39.6% 41.8% 43.0% 43.2% [1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non- Financial Corporations. Source: Moody's Financial Metrics Note: For definitions of Moody's most common ratio terms please see the accompanying User's Guide.
Opinion Rating Drivers - Diverse group of regulated utility businesses operate in credit supportive regulatory environments - Consolidated credit metrics are weak for Duke's A3 rating, but expected to improve - Holding company debt is relatively high at approximately 30% of total consolidated debt - Non-utility businesses add some risk, but are a relatively small part of Duke's overall business - Uncertainty at Duke Ohio with pending generation divestiture, although exit from generation business would be credit positive - Lengthy Duke Indiana Edwardsport IGCC plant testing process has been delayed by cold weather - Duke Carolinas coal ash spill has hurt reputation and increased regulatory, political and public scrutiny of Duke's coal ash ponds, but financial impact is manageable Corporate Profile Duke Energy Corporation (Duke) is a diversified energy company with both regulated utility and unregulated generation operations headquartered in Charlotte, North Carolina. By far its largest business, consist of its Regulated Utilities business segment, which serves approximately 7.2 million retail electric customers located in six US states. The smaller Commercial Power business segment owns, operates and manages power plants, primarily located in the midwest region of the US, including a coal and gas generation portfolio of approximately 6,615 owned MW located mostly in Ohio. On 17 February 2014, Duke announced that it had begun the process of exiting this business after the company's request for a cost-based capacity charge was denied. The Commercial Power segment also includes a renewable energy business (wind and solar), which has approximately 1,700 MW of electric generating capacity in the US, plus 400 MW under development. The company's international business segment, Duke Energy International (DEI), operates and manages power generation facilities, including hydro electric generation, and engages in sales and marketing of electric power, natural gas and natural gas liquids primarily in Latin America. It includes 4,600 MW of owned capacity, about 45% of which is located in Brazil. The company has announced that it will undertake a strategic review of this business in 2014. SUMMARY RATING RATIONALE Duke Energy is the largest utility holding company in the US and its ratings and credit profile reflect the company's diverse, mostly rate regulated business activities, which make up approximately 85% of its overall business. The company's utilities operate in mostly credit supportive regulatory jurisdictions and have resolved a number of key uncertainties in 2013, including those related to several rate proceedings, commercial operation of the long delayed Edwardsport IGCC plant in Indiana, and the decision to retire the Crystal River 3 nuclear plant in Florida. Credit risks include a relatively high level of debt at the holding company level, questions regarding the timing and proceeds from the disposition of its Ohio generation business, and consolidated credit metrics that are weak for its A3 rating. DETAILED RATING CONSIDERATIONS - Diverse group of regulated utility businesses generate the bulk of the company's cash flow Since its merger with Progress Energy in July 2012, Duke Energy's overall credit profile has been for the most part driven by its six regulated utilities operating in six US states. The merger increased the regulatory and geographic diversity of the entire Duke organization and also created the largest regulated nuclear fleet in the country, putting Duke in a stronger position to undertake new nuclear plant development if it decides to move forward in that direction. In February 2014, the company decided not to pursue an ownership interest in the new Summer nuclear plant being built by neighboring SCANA. It has begun discussions with the North Carolina Eastern Municipal Power Agency for the possible purchase of 700 MW of the agency's minority interest in Duke Energy Progress coal and nuclear generating plants.
Duke's pro-forma consolidated cash flow coverage metrics are expected to improve going forward, although they are likely to be somewhat lower than what Duke has exhibited historically. We expect CFO pre-working capital to debt to initially be in the mid to high teens, below the 21% to 23% level the company had exhibited up until 2011. These metrics are slightly weak for the A3 rating level, although this is somewhat mitigated by the diverse sources of cash flow. The lower coverage ratios are partly due to the significant $4 billion of debt at the Progress Energy intermediate holding company. We note that 2012 cash flow coverage metrics were unusually low with Duke exhibiting a consolidated CFO pre-working capital to debt ratio of only 13.4% because, with the merger closing on 2 July 2012, only six months of Progress Energy results are included. For FYE 2013, the company's consolidated CFO pre-working capital to debt improved to 16.7 %, and should improve further in 2014 and 2015. - Utilities operate in generally credit supportive regulatory environments with the resolution of several key uncertainties in 2013 Duke's utility subsidiaries operate in six separate regulatory jurisdictions with mostly above average regulatory environments. In Duke's largest jurisdiction, North Carolina, we viewed rate settlements last year at both Duke Energy Carolinas and Duke Energy Progress as credit supportive. Although there has been some turnover in the composition of the North Carolina Utilities Commission with the appointment of three new commissioners in 2013, we do not expect the overall regulatory framework to change materially. The neighboring South Carolina regulatory environment is also viewed as above average and Duke Carolina's rate settlement in that state was similarly credit supportive. Duke's credit profile also reflects the resolution of several key uncertainties during 2013. These included the commercial operation of the Edwardsport IGCC plant in Indiana, the settlement of issues related to the Crystal River 3 nuclear plant in Florida, and the clarification of succession plans with the appointment of two long-serving executives as CEO and CFO. On 31 January, 2014, five of Duke's subsidiaries (Duke Carolinas, Duke Florida, Duke Indiana, Duke Progress, and Progress Energy) were upgraded by one notch as part of a sector-wide rating action reflecting Moody's more favorable view of the relative credit supportiveness of US utility regulation. The rating of Duke Ohio was not upgraded due to uncertainty regarding Ohio's transition to a deregulated generation market. Duke Kentucky was also not upgraded because of its declining financial metrics, increasing capital expenditures, and anticipated higher debt to finance some of these capital expenditures. - Duke holding company debt is relatively high at approximately 30% of total consolidated debt The combined Duke and Progress holding company debt as a percentage of total consolidated debt is now approximately 30%, up from the 20% range before the merger, and will likely remain at this level as Duke expects to refinance approximately $400 million of additional Duke Ohio debt at the parent company as part of the utility's generating asset transfer. Duke's 2014 financing plan calls for the issuance of $1.76 billion at the Duke Energy parent company, with $1.55 billion of parent company debt securities maturing during the year (including $750 million on that matured on 1 February 2014 and $300 million of Progress Energy holding company debt that matured on 15 March 2014.) The high parent company debt is partly a result of the addition of the more levered Progress Energy holding company to the organization and is a key risk factor for both the Duke and Progress holding company ratings going forward. Offsetting this risk is the increased breadth and diversity of dividends and cash flow sources for the Duke parent company following the merger, as well as the lower percentage of unregulated business activities. When there are multiple subsidiaries providing cash flow and dividends to the parent, the benefits of diversity offset some of the risk associated with higher leverage. Duke current rating and notching assumes that parent company debt will not exceed 30% of the organization's consolidated debt. - Non-utility businesses add some risk, but are a relatively small part of the Duke organization and will decrease further if Ohio generation business is divested Duke's non-utility businesses, especially its commercial power segment, add a degree of risk to the company's overall credit profile, but in total account for a relatively low 15% of its total business. The company's unregulated coal and gas generation in Ohio has been negatively affected by low PJM capacity prices and lower generation volumes, and the company has begun the process of exiting the business. The company's domestic renewable generation has a lower risk profile due to generally long-term contractual nature of its power purchase agreements. Duke's international business consists of approximately 4,600 MW of hydroelectric, gas and other generating facilities in Central and South America, as well a 25% investment in a methanol company in Saudi Arabia. Although
these generation assets in the Americas are highly contracted, experiencing solid earnings growth, and are mostly self-funding from a cash flow standpoint, Duke's access to over $1 billion of cash held at this business is constrained, mostly for tax related reasons. The company recently announced that it would undertake a strategic review of its international businesses. - Uncertainty at Duke Ohio as capacity charge is denied and Duke moves to divest generation business, although exit would be credit positive Although a relatively small part of Duke's overall business, its Duke Ohio utility subsidiary faces some uncertainty resulting from the hybrid nature of its operations, with a stable, lower risk regulated transmission and distribution business offset by a more volatile and higher risk unregulated generation business selling power into the wholesale power markets. The company is in the midst of an Electric Security Plan (ESP) that has resulted in lower revenues, earnings, and cash flow from its generation. Duke Ohio's request to the PUCO for a cost-based capacity charge that would have improved the cash flow generation of these assets was denied on 13 February 2014, with the PUCO indicating that such an approval would not be consistent with an earlier stipulation related to company's current ESP. As a result, Duke has announced its intention to exit the Ohio generation business by selling its generation assets, which it believes are not longer a strategic fit for the mostly regulated organization. The decision will result in a substantial write-down at Duke Ohio which, if necessary, will be supported by equity infusions from the parent company. Duke has also begun the process of transferring Duke Ohio's coal-based generation assets out of the utility, which should be completed over the next 30 days. As part of this restructuring, Duke plans to refinance $400 million of Duke Ohio long-term debt at the parent company level. We would view any exit from the more risky merchant generation business as credit positive. - Commercial operation of Edwardsport IGCC plant was reached in June 2013, although lengthy 15 month testing process has been delayed by cold weather In June 2013, Duke Indiana announced the start-up and commercial operation of the Edwardsport IGCC plant, a key milestone representing a major step toward resolving a significant uncertainty that had faced the company over the last several years. Some execution risk remains however, as the plant is in the midst of a15 month testing and optimization period, much of it related to the gasifiers, a highly complex technology to convert coal into gas, remove pollutants, and burn cleaner gas to generate electricity. Duke Indiana has provided limited public information on the performance and testing of the plant since commercial operation, other than indicating that the company expects to encounter issues with the new technology in the early phases of the plant's operation, although it has not discovered any issues that will impact the plant's long-term performance. In late 2012, Duke Indiana filed a $560 million lawsuit against both General Electric and Bechtel in connection with their work on the plant, with an arbitration proceeding scheduled for October 2014. A 2012 settlement agreement with Indiana regulators capped total cost recovery at $2.595 billon, resulting in a disallowance of project costs of $835 million. Plant costs up to the cap are recovered through an IGCC rider tracking mechanism. We considered the commercial operation of the Edwardsport IGCC plant during 2013 as a positive development, although testing of the plant has been delayed this winter by cold weather, which could result in additional costs before full operation is reached. - Duke Carolinas coal ash spill has hurt reputation and increased regulatory, political, and public scrutiny of Duke's coal ash ponds, but financial impact is manageable On 2 February 2014, Duke Carolinas experienced a break in a storm water pipe under a coal ash pond at its retired Dan River coal plant, which the company estimates leaked 30,000 to 39,000 tons of ash and 24 to 27 million gallons of water into the neighboring Dan River. The break took nearly a week to repair and has opened the company to regulatory, political, and public scrutiny of both its coal ash pond handling and plans for cleaning up its coals ash ponds in North Carolina. The cost of the repair itself has been nominal and although costs to clean, dredge, and return the river to its pre-spill condition could be more material, we do not expect the cleanup to have a significant financial impact on either Duke or Duke Carolinas. However, the spill has damaged both the company's reputation, as well as its relationship with regulatory, political, and public constituencies in North Carolina. The company has received several subpoenas from the US Attorney's office on the spill and other legal actions that call for the immediate cleanup of all of its coal ponds. The North Carolina Department of Environment and Natural Resources has indicated that Duke's proposed plan to clean up its North Carolina coal ash ponds is inadequate and has requested additional information as well as the estimated costs and a timeline for the cleanup. This controversy comes at a time when the US Environmental
Protection Agency is in the process of finalizing rules and regulations on coal ash, which are expected by the end of 2014. Partly depending on whether coal ash is deemed a hazardous waste, the cost to Duke and the industry of the final coal ash rules could be material. Liquidity Profile Duke has an adequate liquidity profile, maintaining a $6 billion bank credit facility at the parent, which includes sublimits for each of its major utility subsidiaries, that matures on 18 December 2018. The facility supports a $4 billion commercial paper program. The facility does not contain a material adverse change clause for new borrowings, and has a single financial covenant, requiring that Duke and its subsidiaries maintain a consolidated debt to capitalization ratio below 65%. At 31 December 2014, all of borrowing entities were in compliance with this covenant. Duke Ohio's ability to meet this covenant could be affected, depending on the level of the impairment taken with respect to its Ohio generation, but Duke is expected to prevent a covenant violation through an equity infusion into Duke Ohio if necessary. In its most recent amendment of the facility extending it to 2018, Duke also raised the parent company's borrowing sublimit to $2.25 billion from $1.75 billion, with a maximum sublimit of $3 billion. The credit facility also includes borrowing sublimits of $1 billion for Duke Carolinas, $750 million each for Duke Progress, $700 million for Duke Indiana, $650 million for Duke Florida, and $650 million for Duke Ohio, which includes $100 million for Duke Kentucky. As of 31 December 2013, Duke had $5.2 billion available under these credit facilities with $450 million of notes payable and commercial paper, $240 million of tax-exempt bonds, and $62 million of letters of credit outstanding. Duke also maintains a money pool arrangement among its utility subsidiaries allowing it to more efficiently utilize available cash balances throughout the organization. In addition to commercial paper, Duke also has the ability to raise short-term debt through a $3 billion variable rate floating rate demand note program, called PremierNotes. The company's filings with the SEC indicate that no more than $1.5 billion of such notes will be outstanding. The notes have no stated maturity date and can be redeemed in whole or in part by Duke Energy or at the investor's option at any time. At 31 December 2013, Duke had $836 million of PremierNotes outstanding, up from $395 million at 31 December 2012. Although not explicitly backed by Duke's bank credit facility, the facility could be used to fund the maturities of such notes As of 31 December 2013, Duke had approximately $1.5 billion of cash and short-term investments on hand. Approximately $1.1 billion of this cash is held offshore in Duke's international businesses, which is not quickly or readily available for liquidity purposes, although the company did return $750 million of off-shore capital to the parent company in December 2013. The company's scheduled debt maturities over the 12 months ending 31 March 2015 total approximately $650 million, including approximately $500 million at the Duke parent company, approximately $150 million at Duke Ohio, and approximately $40 million at Duke Kentucky. We expect that most if not all of this debt will be refinanced. Rating Outlook The rating outlook of Duke is stable, reflecting the relatively low business risk profile and diversity of its predominantly regulated utility businesses, generally credit supportive regulatory environments, and limited nonutility businesses. The stable outlook reflects our expectation that consolidated cash flow coverage metrics will improve and parent company debt will remain at or below 30% of total debt. What Could Change the Rating - Up Duke's rating could be raised if there is a material reduction of parent company debt, if one or more of its larger utility subsidiaries is upgraded, or if the company exhibits improved consolidated coverage metrics, including CFO pre-working capital to debt above 22% on a sustained basis. What Could Change the Rating - Down The company's rating could be downgraded if additional debt is issued at the parent such that parent company debt exceeds 30% of total debt, if there are adverse rate case outcomes or other negative regulatory developments at any of its major utilities, if one or more of its significant utility subsidiaries is downgraded, if the amount or risk of its unregulated business activities increases materially, or if consolidated financial metrics remain weak for its rating, including CFO pre-working capital to debt below 15%. Rating Factors
Duke Energy Corporation Regulated Electric and Gas Utilities Industry Current LTM [3]Moody's 12-18 Month Grid [1][2] 12/31/2013 Forward ViewAs of March 2014 Factor 1 : Regulatory Framework (25%) Measure Score Measure Score a) Legislative and Judicial Underpinnings of the Regulatory Framework A A A A b) Consistency and Predictability of Aa Aa Aa Aa Regulation Factor 2 : Ability to Recover Costs and Earn Returns (25%) a) Timeliness of Recovery of Operating and Capital Costs A A A A b) Sufficiency of Rates and Returns Baa Baa Baa Baa Factor 3 : Diversification (10%) a) Market Position A A A A b) Generation and Fuel Diversity A A A A Factor 4 : Financial Strength (40%) a) CFO pre-wc + Interest / Interest (3 Year 4.7x A 4.5x - 5.0x A Avg) b) CFO pre-wc / Debt (3 Year Avg) 15.7% Baa 18% - 20% Baa c) CFO pre-wc - Dividends / Debt (3 Year 10.5% Baa 13% - 15% Baa Avg) d) Debt / Capitalization (3 Year Avg) 42.8% A 40% - 45% A Rating: Grid-Indicated Rating Before Notching A3 A3 Adjustment HoldCo Structural Subordination Notching -1-1 a) Indicated Rating from Grid Baa1 Baa1 b) Actual Rating Assigned A3 A3 [1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non- Financial Corporations. [2] As of 12/31/2013(L); Source: Moody's Financial Metrics [3] This represents Moody's forward view; not the view of the issuer; and unless noted in the text, does not incorporate significant acquisitions and divestitures. 2014 Moody's Corporation, Moody's Investors Service, Inc., Moody's Analytics, Inc. and/or their licensors and affiliates (collectively, "MOODY'S"). All rights reserved. CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. ("MIS") AND ITS AFFILIATES ARE MOODY'S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND CREDIT RATINGS AND RESEARCH PUBLICATIONS PUBLISHED BY MOODY'S ("MOODY'S PUBLICATION") MAY INCLUDE MOODY'S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MOODY'S DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY
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