DBRS Places TransAlta Corporation Under Review with Developing Implications Following Final Sundance Arbitration Outcome

DBRS has today placed the BBB Unsecured Debt/Medium-Term Notes and Pfd-3 Preferred Shares ratings of TransAlta Corporation (TAC or the Company) Under Review with Developing Implications. This rating action follows the announcement of the final outcome of the arbitration case regarding the force majeure and economic claim of Sundance 1 and 2 coal-fired generation units. The arbitrator concluded that, although the closure was a result of a force majeure, Sundance 1 and 2 can still be economically restored to service. As a result of this outcome, TAC will be responsible for approximately $190 million in estimated repair costs to restart Sundance 1 and 2, as well as for $150 million in accrued penalties to TransCanada PipeLines Limited (TCPL; rated “A” by DBRS), a wholly owned subsidiary of TransCanada Corporation. However, TAC will still be receiving capacity payments totaling approximately $100 million from the Balancing Pool (established by the Government of Alberta) from today to when the units are restored to service, which is expected to be in the fall of 2013. Therefore, the net cash cost for TAC is estimated to be approximately $240 million.

DBRS notes that TAC has a good liquidity profile with total committed credit facilities of approximately $2.4 billion, of which approximately $0.8 billion is currently available. This provides TAC with adequate liquidity to make initial net penalty payments of approximately $150 million with short-term debt. The remaining net cash cost of approximately $90 million is expected to be spread out over the next twelve to fifteen months. TAC’s next bond maturity is not due until December 2013 (US$300 million).

DBRS expects TAC to ultimately fund the majority of the aforementioned costs primarily with equity (including preferred shares and dividend re-investment proceeds) in a timely manner to maintain its current leverage level. Any further increase in leverage could cause TAC’s credit risk profile to deteriorate to a level that is no longer commensurate with the current BBB rating.

Sundance 1 and 2 are expected to commence operations in late Q3 or early Q4 2013. Upon Sundance 1 and 2 restart, DBRS estimates that incremental earnings are expected to be adequate to fund incremental capital expenditures and funding costs, barring any material unplanned turnaround. However, Sundance 1 and 2, and other aging coal plants, could be subject to operating challenges. Furthermore, the additional capacity from Sundance 1 and 2 could potentially have a negative impact on wholesale prices, leading to a decrease in merchant margins. On the other hand, this could be offset by the continued load growth in the Alberta market, which is expected to grow by approximately 300-400 megawatts (MW) annually. For TAC to maintain the current ratings, DBRS expects significant unforeseen costs or cash shortfalls to be funded by equity (including preferred shares and dividend re-investment proceeds).

Through a power purchase agreement (PPA), TCPL has the right to 100% of the 560 MW generating capacity of Sundance 1 and 2. The notice of force majeure was issued in January 2011. In February 2011, TAC issued a notice of termination for the Sundance 1 and 2 PPA after determining that the units cannot be economically restored to service. TCPL and the Balancing Pool disputed this claim under the binding dispute resolution process provided in the PPA. Arbitration on this matter was heard in the first half of 2012 and the decision was received on July 20, 2012.

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

The applicable methodology is Rating Companies in the Non-Regulated Electric Generation Industry, which can be found on the DBRS website under Methodologies.