DBRS Confirms Capital Power Income L.P. at STA-2 (low)

DBRS has today confirmed the stability rating of Capital Power Income L.P. (the Partnership or CPILP) at STA-2 (low), based on the stable cash flow from its long-term power contracts, strong operational efficiency and diversification of assets. In 2009, DBRS downgraded the stability rating twice, from STA-2 (high) to STA-2 (middle) then to STA-2 (low), to reflect, respectively, the increase in the Partnership’s debt-to-capitalization and the reduction in annual distributions by 30%. The Partnership previously stated that the reduction in distributions was needed to support its growth initiatives, maintain stable and predictable distributions and preserve its creditworthiness. The Partnership believes the revised level is sustainable for the next five years, whether it remains a partnership or converts to a corporate entity, and its targeted payout ratio (after maintenance capex) was revised to approximately 75%. The distribution reduction resulted in the conservation of approximately $40 million in cash annually. The Partnership’s generating portfolio has a mix of power purchase agreements (PPAs), with a weighted-average life of approximately 11 years, which underpins the cash flow used to make cash distributions.

The Partnership also continues to achieve strong operating efficiencies, with five-year average availability at 93%, reflecting the young fleet of generating assets and sound operational and maintenance practices. Approximately 51% (DBRS estimate) of the operating margins originate from facilities that have PPAs with a weighted-average life greater than ten years, while 83% of the operating margins are derived from PPAs with a weighted-average life greater than five years.

Renegotiating and re-contracting PPAs that expire in the near to medium term remain key challenges for the Partnership. Currently, DBRS estimates that approximately 20% of total installed capacity (17% of operating margin) with PPAs will expire within five years. The PPAs for the North Carolina plants expired in December 2009 and the Partnership has been unable to negotiate acceptable terms with the counterparties following its enhancement investment of US$71 million in 2009 (total projected cost of US$87 million). CPILP is currently in arbitration with Progress Energy Inc., with the decision still pending. The North Carolina Utilities Commission (NCUC) has ordered that the counterparty continue to pay for the output of the facilities until the arbitration is finalized in Q3 2010 or Q4 2010. DBRS expects the Partnership will continue to take reasonable steps that will result in new PPAs for the facilities; however, as stated by the Partnership, it is not certain that the final contract terms will result in positive cash flow as previously expected.

In addition to maintaining and improving its performance, DBRS expects the Partnership will continue to seek growth opportunities in projects that are accretive to cash flow. CPILP will continue to have a right of first look on the sale of generation assets of its sponsor, Capital Power L.P.; however, this has not been a material source of growth in the past. The ability of the Partnership to continue to improve its operating performance, enhance revenue by ensuring it renegotiates and renews expiring PPAs at economically acceptable terms and secure long-term energy supply and operating contracts remains key to its cash flow stability and thus maintaining stable distributable cash flow. Further weakness in distributable cash flow could affect the stability rating of the Partnership.

The Partnership has maintained that it does not expect to make any material cash income tax payments until at least 2015 because of the tax pools available to offset taxable income; therefore, the Partnership has no compelling need to convert to a corporation at this time, but it will continue to evaluate its options.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating North American Energy Utilities (Electric, Natural Gas, and Pipelines), which can be found on our website under Methodologies.

This is a Corporate (Utilities & Independent Power Utilities) rating.