New York (Platts)--28Feb2011/529 pm EST/2229 GMT

Smaller coal plants concentrated in five contiguous states in the US Midwest are the most likely to be retired if tougher environmental rules are adopted, Fitch Ratings said Monday in a special report.

For plant owners, a key driver on credit impact will be the time between adoption of the rule and the compliance deadline, assuming there is no court intervention, the ratings agency said.

But Fitch also noted in the report, "Time to Retire? US Coal Plants in Environmental Crosshairs" that "it is likely federal legislation and [US Environmental Protection Agency] regulations may be held up by political uncertainty and judicial challenges."

The credit impact of plant retirements on particular entities will depend on several issuer-specific factors, including: certainty of environmental regulation; the power-supply mix relative to the region; state environmental initiatives; the flexibility to adjust rates; recourse to regulated cost recovery; and the entity's debt, leverage, and capital structure, the Fitch report says.

While lead author Director Bhala Mehendale is in the public power group, the report deals with the entire industry and did not focus on specific generators.

"There have not been any instances over the decades since the initial passage of the Clean Air Act and Clean Water Act in which utilities have been denied cost recovery and capital recovery of such expenditures," Fitch noted. Most at risk for retirement are about 16,700 MW of plants concentrated in Indiana, Illinois, Michigan, Ohio, and Pennsylvania. Most of the plants are below 200 MW and average nearly 50 years old, Fitch said.

Tennessee is the state with the most such capacity (3,985 MW, or 40.7% of total state coal capacity), followed by Ohio (3,762 MW, or 16.2%), Indiana (3,744 MW, or 17.8%), Michigan (3,715 MW, or 29.9%) and Kentucky (3,450 MW, or 20.7%).

Smaller plants are generally older and less likely to have gotten the investment necessary to comply with evolving environmental rules. Thus the required investment per kilowatt and percentage increase in operating costs -- and therefore impact on cash flow -- would be greater, Fitch said.

"There is not an economic case for owners of old and small power plants to incur the high capital investments and increased operating costs to retrofit such units to comply with multiple rules affecting various pollutants. It is therefore likely that the combination of older and smaller coal units will result in this region seeing the most retirements," the author, Mehendale, added.

The large amount of potential retirements in this region may affect reliability enough to require new generation, transmission upgrades, temporary reliability must-run contracts, or a combination, Fitch said.

--Paul Carlsen, paul_carlsen@platts.com

Similar stories appear in Coal Outlook. See more information at http://bit.ly/CoalOutlook