TEXT-Fitch cuts OGE Energy's IDR to 'A-'
June 20 - Fitch Ratings has downgraded the Long-term Issuer Default Rating (IDR) of OGE Energy Corp. (OGE) to 'A-' from 'A' and the Short-term IDR and Commercial Paper rating to 'F2' from 'F1'. Simultaneously, Fitch has affirmed Oklahoma Gas & Electric Company (OG&E) at 'A' and Enogex LLC (Enogex) at 'BBB'. The Rating Outlook for all entities is Stable. Approximately $2.7 billion of debt is affected by these actions. A full list of rating actions follows this release. KEY RATING RATIONALE: OGE The downgrade at OGE primarily reflects the concerns over the uncertainties associated with the environmental mandates at its primary subsidiary OG&E, a regulated, integrated electric and gas utility serving Oklahoma and western Arkansas. In 2011, approximately 56% of the electricity at OG&E is generated from coal-fired generating facilities. OG&E is required to comply with a number of environmental mandates over the next few years. The regional haze dispute with the EPA causes most concern at this juncture. Fitch views the outcome of the settlement of Public Service Co. of Oklahoma (PSCOK) with the EPA over regional haze in April 2012 a likely outcome for OG&E. In the settlement, PSCOK has agreed to install the emission control equipment in one unit in 2015 and retire the other in 2016. Currently OG&E requested a federal appeals court to stay the haze rule intended to improve visibility at national parks and wilderness areas through emissions cuts from coal-fired power plants, which could result in installing scrubbers at four of OG&E's coal-fired units. The cost is estimated to be over $1 billion. Though Oklahoma legislation allows utilities to recover cost from environmental mandates at the state and federal level and OG&E has several years to implement the various mandates, Fitch believes that the issue has become less in OGE's favor over time and will change its overall business risk profile permanently, especially due to the fact that OGE has yet to incorporate a meaningful amount of environmental spending in its business plans. Fitch believes that OGE will need to downstream substantial equity into OG&E, estimated at approximately $500 million, in order for OG&E to finance the potential environmental investments and maintain its capital structure. Additionally, Fitch believes that the environmental cost recovery could potentially affect the future recovery of OG&E's planned capital spending program. The downgrade also reflects the still sizeable commodity sensitive portion of the midstream business at Enogex, a midstream subsidiary, and the increasingly aggressive growth strategy since OGE and ArcLight established the partnership in 2010, which offset the efforts to reduce operating risk by shifting to fixed-fee contracts. Fitch also notes that the fixed fee contracts remain to be affected by volume risk due to lack of minimum volume commitment. Though on a standalone basis, each of OGE's subsidiaries is expected to produce credit metrics that are in line with their respective rating categories, Fitch believes that on a consolidated basis, the operating risk at OGE is increasing. Hence, the new ratings will reflect more accurately the relative credit risks at each entity within the capital structure. OGE's Stable Outlook reflect a business mix that is mostly supported by OG&E, a regulated electric utility in Oklahoma, and the ongoing effort to manage the commodity sensitive midstream business. Fitch expects OGE to derive more than 70% of the EBITDA from OG&E in the next few years. There could be negative pressure on OGE's ratings if OG&E's ratings become pressured due to substantial debt financing for its large capital expenditure program, or if there is significant lag in recovery for investments and environmental mandates through customer tariffs. Additionally, Fitch would be concerned if OGE could not manage Enogex's commodity exposure successfully, or if Enogex becomes more aggressive in pursuing merger and acquisitions resulting increasing leverage substantially. OGE's consolidated fund from operations (FFO) to debt was 26.5% in 2011 versus 28.5% in 2010 and 26.8% in 2009. Leverage defined as debt to EBITDA was 3.1 times (x) versus 2.8x at the end of 2010 and 3.4x at the end of 2009. These metrics will be under some pressure as its subsidiaries are taking on relatively large capital spending programs over the next three years. Fitch expects OGE to produce FFO to debt ratio in the low to mid 20% and debt to EBITDA ratio in the high 2x to low 3x in the next three years. OGE and its subsidiaries have access to liquidity through approximately $1.55 billion of revolving credit facilities, of which approximately $900 million is available. There are no maturities of long-term debt until 2014 when $300 million of senior notes are due. OG&E The ratings for OG&E are supported by its strong financial position, low business risk of its integrated electric utility operations, the relatively resilient economy within its service territory and a constructive regulatory environment. OG&E's rating stability depends on continued regulatory support on both growth investments and environmental mandates. The uncertainty surrounding the environmental mandates associated with its primarily coal-fired generation fleet is a major credit constraint. Additionally, OG&E is investing in approximately $2.5 billion of known and committed projects for wind, transmission and smart grid investments in the next five years. Regulatory lag or under-recovery could put downward pressure on OG&E's credit metrics. In 2011, OG&E produced FFO to debt of 24.3% versus 26.9% at the end of 2010 and 34.1% at the end of 2009. Going forward, in the absence of bonus depreciation, we expect this ratio to stay at low 20% range over the next few years. OG&E's Stable Outlook assumes continued control over operation and maintenance (O&M) expenses, and constructive regulatory outcomes in future rate proceedings. In 2011, OG&E filed for a $73.3 million increase in base rates based on an authorized return on equity of 11% and 53% equity base; a decision is expected over the next few months. It is also Fitch's expectation that most of OG&E's planned capital investments will receive pre-approval from Oklahoma Corporation Commission ensuring a clear recovery mechanism. Enogex Enogex's ratings are supported by strong cash flows generated by its portfolio of natural gas transportation, storage, gathering and processing businesses. The ratings also reflect the continued effort to reduce business risk by shifting the processing revenue towards fixed-fee contracts. In 2012, we expect that 60% of the gross margin will come from these contracts. Commodity price exposure and prudent financial practices are Fitch's main rating concerns. The commodity price concern would increase if there was growth in the proportion of commodity sensitive non-regulated businesses or a change in hedging strategy that would increase the company's exposure. Other concerns would include adoption of a more aggressive business model. We assess Enogex's credit quality by applying rating criteria for midstream energy companies including master limited partnerships. Leverage defined as debt to EBITDA was 2.6x in 2011 against 1.9x at the end of 2010 and 3.4x at the end of 2009. Distribution coverage ratio defined as (adjusted EBITDA-maintenance capex-interest expense)/cash distribution was 1.2x in 2011. Going forward, we expect the debt to EBITDA ratio to be in the mid to high 2x and the distribution coverage ratio to be around mid 2x. Enogex's Stable Outlook assumes that the proportion of fee-based businesses will continue to grow as a percentage of consolidated operating income. We would be concerned if Enogex takes on overly aggressive growth projects or aggressive distribution policy resulting in substantial increase in leverage. Fitch downgrades the following ratings: OGE Energy Corp. --Long-term IDR to 'A-' from 'A'; --Senior unsecured debt to 'A-' from 'A'; --Short-term IDR and commercial paper (CP) to 'F2' from 'F1'. Fitch has affirmed the following ratings: Oklahoma Gas & Electric Company --Long-term IDR at 'A'; --Senior unsecured debt at 'A+'; --Short-term IDR and CP at 'F1'. Enogex LLC --Long-term IDR at 'BBB'; --Senior unsecured debt at 'BBB'. Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings. Applicable Criteria and
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