OREANDA-NEWS. Fitch Ratings does not expect FirstEnergy Corporation's (FE; 'BB+'/Outlook Positive) ratings to change as a result of the Public Utilities Commission of Ohio's (PUCO) approval of FE's electric security plan (ESP) IV settlement. The PUCO approved the ESP IV settlement with some modification. All else equal, Fitch expects FE's consolidated business risk profile and operating cash flows to improve with implementation of the eight-year PUCO authorized rate plan.

The rate plan's affiliate purchased power agreement (PPA) is highly controversial and Fitch expects motions for rehearing to be filed at the PUCO and that the decision will be subject to judicial review. In addition, two complaints have been filed with the Federal Energy Regulatory Commission as to waivers granted to FE in 2008 regarding affiliate transaction restrictions and seeking modification of PJM Interconnections, Inc.'s minimum offer-price rule to address subsidies.

The rate plan authorizes a retail rate stability rider (RSR) for recovery of costs associated with FE's Ohio operating utility subsidiaries' PPA with affiliate FirstEnergy Solutions (FES). In Fitch's opinion, the affiliate PPA provides FES with a more predictable source of revenue and cash flow, resulting in an improved credit profile from both a qualitative and quantitative point-of-view.

Under ESP IV, FE's operating utility subsidiaries, Ohio Edison Company (OE), The Cleveland Electric Illuminating Co. (CEI), and The Toledo Edison Co. (TE), will purchase power from FES at a cost-based rate and sell it in the wholesale power market. Differences between the cost of the affiliate PPA and amounts received in wholesale markets will be charged or credited to OE, CEI and TE's ratepayers through a rate stabilization tariff. However, the mechanism is subject to a PUCO modification precluding changes in average customer bills June 1, 2016 - May 31, 2018.

On balance, Fitch believes the PUCO authorized settlement is credit supportive, notwithstanding a freeze on base distribution rates through the eight-year term of ESP IV (June 1, 2016 - May 31, 2024) and the commission's modification barring increases to average customer bills June 1, 2016 - May 31, 2018. Fitch notes that unrecovered costs associated with the PUCO-imposed average customer bill restriction may be deferred for future recovery in the second fiscal year of the two-year period (i.e. June 1, 2017 through May 31, 2018).

Provisions in the approved ESP IV settlement also include revenue caps on the utilities' distribution capital recovery rider and a guaranteed $100 million of total rate credits in years 5 through 8.

In Fitch's opinion, ESP IV aligns FE's corporate strategy with Ohio energy policy goals to reduce carbon emissions while providing a path to timely recovery of related costs. OE, CEI and TE are committed under the commission authorized settlement to reduce carbon emissions by at least 90% below 2005 levels by 2045. Under the rate plan, investment in grid modernization is to be recovered through a forward-looking tariff mechanism based on a 10.38% return on equity.

In addition, OE, CEI and TE will file a rate proceeding with PUCO to phase in fixed / variable rates starting at 25% fixed / 75% variable in 2019 and moving to 75% fixed / 25% variable in 2021.