DBRS Comments on the Lower Churchill Announcement

DBRS notes that, at a joint news conference in St. John’s on November 18, 2010, the Province of Newfoundland and Labrador (Newfoundland or the Province) and the Province of Nova Scotia (Nova Scotia) announced an agreement (the Agreement) to develop the hydroelectric generation potential of the lower Churchill River in Labrador. The project will involve the construction of an 824-megawatt generating station at Muskrat Falls; a subsea transmission connection under the Strait of Belle Isle, which separates the island of Newfoundland from Labrador; and a subsea connection under the Cabot Strait between Cape Breton, Nova Scotia, and Newfoundland. Successful completion of the project, expected by the Province to be in 2017, will allow lower Churchill power to be used on the island of Newfoundland and in Nova Scotia, with surplus energy available for sale to the other Atlantic provinces and the New England states.

On November 16, 2010, DBRS confirmed the long-term and short-term debt ratings of the Province at “A” and R-1 (low), respectively, with a Stable trend on both ratings. DBRS addressed the potential development of the lower Churchill in its rating report, stating that the development is considered to be a net positive to the Province over the longer term. However, given the nature and significant size of the project, it could put the Province’s ratings under stress in the short to medium term, depending on the financing structure used.

The Province has indicated that the financing strategy is still being developed and as such, only a few details are known. Based on early estimates, the total cost of the project is expected to be $6.2 billion, of which Newfoundland would be responsible for $4.4 billion, with the remainder being funded by Emera Inc. (rated BBB (high)), the parent company of Nova Scotia Power. Newfoundland anticipates funding a portion of its cost through direct lending, supported by taxpayers, with the remainder being funded through Nalcor Energy, the provincially owned energy company, and supported by electricity ratepayers. It is also expected that the Province will seek a loan guarantee from the federal government for some or all of the provincial portion of the debt, which could help lower the overall financing cost of the project.

As detailed in the rating report of November 16, 2010, for the fiscal year ending March 31, 2011, Newfoundland’s DBRS-adjusted total debt is expected to stand at $9.0 billion and points to a debt-to-gross domestic product (GDP) ratio of 32.7%. Adding $4.4 billion would bring Newfoundland’s total debt to $13.4 billion, or roughly 48.4% of GDP. However, it is expected that the Province’s portion of the project debt will be less than the full $4.4 billion as some components of the cost are expected to be funded through limited-recourse project debt and internally generated funds from Nalcor Energy’s other business operations. The Province’s debt portion would also be funded over a number of years, providing an opportunity for GDP growth to provide a partial offset. If sufficient debt is incurred by the Province, the current ratings could become severely stressed, although any rating downgrade would likely be limited to one notch, provided that cost overruns and difficulties encountered during the construction phase are well managed.

DBRS notes that the ratings of Newfoundland and Labrador Hydro (Hydro) are a flow-through of the Province’s ratings. Therefore, any change to the Province’s ratings would have a similar impact on Hydro’s ratings.

Notwithstanding any potential short-term pressure on the rating, DBRS feels that it is important to stress that the lower Churchill project must be seen as a very positive development for the Province. Individuals and businesses often balance the short-term risks of a given course of action or investment in light of potential long-term benefits. Long-term benefits of the project are substantial and include a renewable source of revenue and a conduit through which the Province’s energy resources can reach the consumers of New England. On this latter point, it should be noted that the Muskrat Falls development does not exhaust the hydroelectric generating potential of Labrador as the larger, 2,250-megawatt Gull Island project remains on the horizon. The ability to export electricity would significantly bolster the provincial economy and, when combined with considerable offshore oil and gas resources, suggests that Newfoundland may be poised to enter an era of prosperity on a more sustainable basis.

Many details of the lower Churchill development remain to be finalized before the November 30, 2011, deadline set by the Agreement, including land claims issues, environmental assessments, the ultimate financing structure and the potential role of the federal government. With so many variables unresolved, DBRS remains comfortable with the Province’s current ratings. DBRS will monitor events closely and will take such action as it determines to be appropriate when sufficient information becomes available.

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

The applicable methodology is Rating Canadian Provincial Governments, which can be found on our website under Methodologies.