Credit Research
HurricaneIda:TheOutlookforUtilities,Energy,andChemicals
5 mins
Hurricane Ida made landfall in Louisiana early on Sunday, August 29th, bringing heavy rainfall and sustained winds reaching 150 mph. Hitting New Orleans on the 16th anniversary of Hurricane Katrina, the Category 4 hurricane drew immediate comparisons to its predecessor. However, we believe a replay of what happened in the aftermath of Hurricane Katrina is unlikely. For one, the levees built up following Hurricane Katrina prevented widespread flooding, which should limit the overall damage and prevent migration away from the city. In addition, many producers in the Gulf Coast now have well-rehearsed preparedness plans and protocols to manage disruptions, thus limiting long-term effects.
While by no means comprehensive, the following post outlines our views on three industries likely to be among the most impacted and what Hurricane Ida and its aftermath might mean for bondholders.
The Utility Sector Impact
Hurricane Ida, which came ashore west of New Orleans, caused widespread damage to the electrical grid in Louisiana. According to poweroutage.us, approximately 1 million residents of the state were still without power two days after the storm. Full restoration is expected to take at least three weeks.
Entergy (Baa2/BBB) is the largest utility in the state and will be responsible for rebuilding an estimated 2,000 miles of downed lines with assistance of roughly 25,000 workers from other utilities. The financial repercussions on Entergy will likely be weaker credit metrics over the short term. This will come on top of metrics already weakened due to the effects of prior storms. For Entergy, 2020 was a particularly bad year, with roughly $2 billion of storm damage.
While damage from Ida was very extensive, a replay of what happened after Hurricane Katrina is unlikely. Following that storm, Entergy New Orleans (Baa2/BBB+)—a small subsidiary that serves the city—filed for bankruptcy. A combination of widespread destruction and a migration away from the city left the utility highly compromised. With Ida, potential damage in the city is likely to be more moderate given improved flood control infrastructure.
For Entergy Louisiana (A2/A), a larger subsidiary serving much of the rest of the state, its bigger balance sheet should provide some stability during the rebuilding process.
We would expect Entergy’s credit metrics to eventually recover given the support of Louisiana’s regulators and expectations of securitization proceeds. While utilities can generally recover storm costs from customers, it may take months or years to be reimbursed. However, this lag can be mitigated by financing tools such as securitization which help source low-cost capital to fund system restoration. Securitizations are common and are generally used to reduce short term debt that utilities borrow to fund storm repairs. Credit rating agencies usually take a long-term view and will resist downgrades as long as securitizations are forthcoming.
While securitization will likely help mitigate the costs of Ida, if massive storms become common enough, the pancaking of surcharges from successive storms will start to pressure customer bills and could potentially cause political pushback. So, for investors, it makes sense to follow climate patterns and consider the effect on utilities vulnerable to major weather events (hurricanes, floods, freezing snaps, droughts, etc.). In extreme cases it may be warranted to demand extra spread for the risk of a changing climate.
Figure 1
Utilities, Energy, and Chemicals Spreads Over Time
Bloomberg. Bloomberg Barclays U.S. Corporate Utilities, Energy, and Chemicals Index as of August 31, 2021.
Energy Sector Impact
We expect the effect on the energy industry to be limited. Although significant energy infrastructure was located in the path of the storm, those facilities are generally well prepared (Gulf Coast hurricanes are not unusual) and in the years since Hurricane Katrina management teams have put in place well-rehearsed protocols to manage disruption.
We estimate about 10% of US refining capacity and about 15% of US oil production is currently off-line, and although we do not know the extent of the damage (companies are still assessing) it is worth remembering that Hurricane Harvey, which was arguably the worst storm the industry has seen, only saw 4-6 weeks of disruption with very limited impact to credit fundamentals. Although several refineries in Louisiana are closed, investment grade refining companies have portfolios of facilities and refineries outside the storm’s path and are now benefiting from higher margins as a result of the closures, which is a meaningful offset.
Most Gulf of Mexico oil production is located in deep water where storm surge is not an issue. While we expect some sloppy Q3 financial results from certain operators due to repairs and supply chain disruptions (e.g. Marathon Petroleum Corporation (Baa3/BBB-), Valero Energy Corporation (Baa2/BBB), Phillips 66 (A3/BBB+), Occidental Petroleum Corporation (Ba2/BB), Hess Corp. (Ba1/BBB-), and Colonial Pipeline (A3/A)), we do not anticipate a major impact for bondholders.
Chemical Sector Impact
As severe storms are not uncommon in the Gulf Coast region, chemicals producers have developed more comprehensive and well-defined preparedness plans that are designed to minimize production interruptions. In accordance with these plans, several chemical companies safely shut down or curtailed their Louisiana operations leading up to Hurricane Ida’s arrival. The hurricane made landfall at a time when supply is tight, inventories are lean, and prices are at record highs for many chemical products.
Closures of vital infrastructure such as ports, roads, and railroads, as well as power outages, will impact the restart of chemical facilities and could exacerbate already tight markets. Currently, roughly 39% of US PVC capacity, 9% of US polypropylene capacity, and 18% of US polyethylene production is believed to be offline. While we have yet to hear from all potentially impacted companies, the several that have reported thus far did not experience significant damage from the storm.
In the investment grade chemicals sector, Dow Chemical Company (Baa2/BBB) and Westlake Chemical Corp. (Baa2/BBB) pre-emptively shut their polyethylene and PVC facilities in Louisiana ahead of the storm, while Nutrien (Baa2/BBB) and CF Industries (Ba1/BBB-) shut their nitrogen facilities in the area. We acknowledge that we could see some lost production that may impact the sector’s Q3 financial results. However, overall, we expect the additional supply pressure to lead to higher prices, which should be a meaningful offset to the temporary loss of production. This will likely provide a net benefit, in varying degrees, to Chevron Phillips Chemical (A2/A-), LyondellBasell Industries (Baa2/BBB), Huntsman Corporation (Baa3/BB+), Dow, Westlake, Nutrien, and CF Industries.