Tougher regulatory settlement may signal downgrade for SGN

Ratings agency Moody’s has warned it may downgrade Scotia Gas Networks’ (SGN’s) gas networks in the south of England and Scotland, after Ofgem said it would take a less generous approach in the five years from 2021.
Southern Gas Networks plc and Scotland Gas Networks were not downgraded but Moody’s said they were on ‘negative watch’. It said a methodology consultation published by Ofgem in December “signals a sharp cut in allowed returns and reduced scope for financial outperformance in the RIIO-GD2 period that begins in April 2021.”
Ofgem is consulting on mechanisms to support companies in financial distress, but “this is unlikely to provide support to Scotland GN and Southern GN at the current rating levels,” Moody’s said.

It noted that because the SGN has high gearing, it has more exposure to the reduction in returns and opportunities for outperformance signalled by Ofgem – even though both operating companies have significantly outperformed regulatory assumptions in the current period.

Moody’s highlighted Ofgem plans for a lower measure of inflation. “This change to the indexation of companies’ revenues and Regulatory Asset Value will increase cash flows over the medium term… but will also create a mismatch between regulatory asset growth and SGN’s portfolio of RPI-linked debt,” said Moody’s.
Moody’s noted the companies’ low business risk as the monopoly providers of gas distribution services in Scotland and the South of England, the well-established and transparent regulatory regime, and the companies’ strong performance against all regulatory outputs in the first five years of the current price control, which runs until March 2021.

But it also noted that the regulatory review for RIIO-GD2 is still in progress and key decisions remain outstanding, including on allowed returns. The ratings could be downgraded if announcements by Ofgem further reduce likely returns.

Further reading

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