DBRS Confirms Nova Scotia Power Inc. Unsecured Debentures & Medium-Term Notes at A (low), Cumulative Preferred Shares at Pfd-2 (low), Commercial Paper at R-1 (low) and Stable Trends

DBRS has today confirmed the ratings of the Unsecured Debentures & Medium-Term Notes, Commercial Paper and Cumulative Preferred Shares of Nova Scotia Power Inc. (NSPI or the Company) at A (low), R-1 (low) and Pfd-2 (low), respectively, all with Stable trends. The ratings reflect stable and predictable regulated cash flows generated by the Company’s regulated monopolistic operations, diverse customer base and a supportive regulatory environment.

The certainty of fuel cost recovery from customers through the implementation of the fuel adjustment mechanism is expected to contribute to predictable earnings and cash flow at NSPI. Although the Nova Scotia Utility and Review Board (UARB) approved in full the recovery of the 2010 FAM balance, NSPI was allowed to recover only 50% of the increase in 2011 (which resulted in an average increase of 4.5% for customers), 30% in 2012 and 20% in 2013. While the deferred recovery is seen as a negative, the amount deferred ($53 million) is not viewed as material enough to have an impact on NSPI’s ratings. However, future deferrals of amounts significant enough to affect NSPI’s liquidity could have an impact on ratings.

Customer electricity rates are expected to increase by 5.1% in 2012, pending approval from the UARB. The last rate increase sought and granted to NSPI was 9.3% in 2009. NSPI did not request an increase in customer rates in 2010 and for 2011, but it is expected seek an increase in customer rates in 2013 and 2014 as its rate base grows.

While NSPI’s internal cash flow from operations remains strong and continues to cover both maintenance capex and dividends to Emera Inc. (Emera), which wholly owns NSPI, high-growth capex continues to lead to modest free cash flow deficit, which is being financed with debt, thereby putting some pressure on the Company’s credit metrics. Capital expenditure in 2010 totalled $527 million, the highest investment of the NSPI in at least ten years.

Even though NSPI’s market remains mature, with annual growth of approximately 1%, high-growth capex continues to be driven by new investments in renewable generation mandated by the Province of Nova Scotia (the Province or Nova Scotia). Government legislation for renewable targets has created an opportunity for growth in rate base over the next few years and so DBRS expects capex to remain high at NSPI in the medium term. It is estimated that total capex will average between $300 million and $500 million annually over the next three years, with growth capex accounting for approximately 50% to 70% (DBRS estimate) of this total.

It is expected that these projects will be funded with cash flow from operations, some debt issuance and management of NSPI’s dividends to Emera. Dividends will continue to be paid to Emera such that NSPI’s equity in the capital structure is maintained at or below the approved level of 40%. During this period, investment in growth projects and the lag occurring between when projects commence, when they are completed and when they start to generate cash flow are expected to put some pressure on NSPI’s credit metrics, although its metrics continue to adequately reflect the current ratings. Each project must receive approval from the UARB before NSPI can proceed to ensure that the investment will be included in the rate base. We expect the Company’s metrics to recover over the long term as projects are included in rate base.

DBRS continues to monitor the longer-term development and impact of the proposed Maritime Link project, a subsea transmission link from Newfoundland to Nova Scotia, which is 100% owned by Emera, and Emera’s 29% interest in the transmission link (Labrador Island link) between the island of Newfoundland and Labrador. The Maritime Link project is estimated to cost $1.2 billion; with an in-service date of late 2016, construction is expected to start in 2014. It is expected that the investment would be spread over the 2013 to 2016 time frame and would receive full regulatory approvals before proceeding. Emera is currently exploring various ownership structures for the Maritime Link project, including having the project in NSPI’s rate base. In exchange for its Maritime Link investment, Emera will be entitled to 20% of the output (this amount of power represents approximately 8% to 10% of Nova Scotia’s domestic needs) of the 824 MW Muskrat Falls facilities and will be responsible for 20% of the operating costs of the entire project for 35 years. Emera’s investment of $610 million in the Labrador Island link, to be developed jointly with Nalcor Energy (Nalcor), is expected to be funded through a combination of equity and debt in such a way that its capital structure remains stable.

The project is not yet certain, as final agreement is subject to a number of conditions, including final approval of the boards of directors of Nalcor and Emera and by regulators in both provinces. While the proposed investment is considered significant for Emera, the project is expected to help Emera reduce its greenhouse gas emissions and meet the renewable targets set by the Province for 2020. DBRS expects the full regulatory approvals will be received before proceeding and the project will be funded in line with the prescribed regulatory capital structure.

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.