DBRS Confirms Terasen Inc. at BBB (high), Stable Trend

DBRS has today confirmed the rating for the Medium-Term Note Debentures (MTNs) of Terasen Inc. (TER or the Company) at BBB (high). The trend is Stable. The rating of TER reflects the low business risk profile and stable cash flows of its regulated utility subsidiaries, stable credit metrics and the strong parental support of its parent, Fortis Inc. (FTS, rated A (low)). The rating also reflects the regulatory ring-fencing and structural subordination considerations at its subsidiaries as well as the long-term competitiveness of natural gas vis-à-vis alternative energy sources. TER is the holding company of three natural gas distribution utilities, Terasen Gas Inc. (TGI, rated A and R-1 (low)), Terasen Gas (Vancouver Island) Inc. (TGVI) and Terasen Gas (Whistler) Inc. (TGWI), collectively referred to as the Utilities, as well as a 30% interest in Customer Works L.P. (a customer service provider), and 100% of Terasen Energy Services (an alternative energy solutions provider).

The regulatory environment for TER’s regulated subsidiaries remains stable and continues to provide for a number of cost-recovery mechanisms which, when combined with the rate-setting methodology, allow for a full recovery of all prudently incurred operating expenses and capital expenditures within a reasonable time frame. In late 2009, TGI (which contributes to ~75% to 80% of TER’s earnings) executed a negotiated settlement agreement (NSA) that established rates for 2010 and 2011. The settlement excluded the performance-based rate (PBR) mechanism, under which TGI had operated since 2004. The PBR had allowed TGI the opportunity to share earnings above the allowed return on equity (ROE) with customers on a 50/50 basis and had been beneficial to TGI as it had provided, on average, over $11 million per year in earnings in 2008 and 2009. While the loss of PBR income would have potentially negatively affected TGI’s financial results, the British Columbia Utilities Commission’s (BCUC) December 2009 cost of capital decision largely offset the potentially adverse impact by increasing TGI’s allowed ROE to 9.50% from 8.47% and equity thickness to 40.00% from 35.01%, effective July 2009. TGVI and TGW’s ROEs were also increased to 10.00% from 9.14% and 8.97%, respectively, while the deemed equity components remained unchanged at 40%. As a result, TGI and TGVI continue to generate stable returns, reflecting the regulated nature of their operations and their limited exposure to gas cost.

DBRS anticipates that the trend of lower customer growth at TGI and TGVI will continue given fewer new housing starts in their respective service territories and a shift in the housing mix to more multi-family dwellings that do not typically utilize natural gas. This trend is expected to be mitigated by a focus on retaining customers through expanded energy conservation and efficiency programs.

TGVI’s $200 million Mt. Hayes liquefied natural gas (LNG) storage facility which commenced construction in 2008 is nearing completion with an expected in-service date of Q2 2011. While the project will increase TGVI’s rate base upon completion, TGI is contracting for two-thirds of the storage capacity, providing incremental earnings and cash flows not sourced from TGVI’s existing customer base.

Minimal-to-modest free cash flow deficits continue to be expected at TGI and TGVI over the medium term, attributable to the replacement and refurbishment of existing infrastructure (which is anticipated to go into the rate base in a timely manner), and modest customer growth. On a consolidated basis, TER’s overall credit profile is anticipated to remain reasonably consistent and adequate for its current ratings, with metrics in the range of debt-to-capital of 65%, EBIT-to-interest expense of 2.0x and CFO-to-debt of 8%. Modest improvements with TGI, and thus TER’s credits metrics may be attributed to the recent approved regulatory decisions. TER’s EBIT-to-interest expense and CFO-to-debt ratios are generally lower than those of its peers primarily due to lower figures at TGI. Non-consolidated metrics also support ratings, with dividend payments from TGI alone expected to be more than sufficient to cover TER’s non-consolidated annual interest obligations.

Note:
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.