DBRS Comments on Ontario Power Generation Inc.’s Q2 Earnings

DBRS notes that on August 24, 2012, Ontario Power Generation Inc. (OPG or the Company; rated A (low)) reported earnings of $197 million for the six months ending June 30, 2012 (H1 2012), which declined significantly from the reported earnings of $262 million for the same period in 2011 (H1 2011). The decline was mainly attributed to the Company’s unregulated hydroelectric operations, which reported a loss before interest and income taxes of $5 million (versus an EBIT of $115 million in H1 2011). The lower reported earnings in the unregulated hydroelectric segment were a result of a lower weighted-average hourly Ontario electricity price (HOEP) and electricity generation.

Lower earnings in H1 2012 were mainly driven by lower natural gas prices (which set the marginal clearing price in most peak demand hours) and below normal water levels. Earnings for OPG’s unregulated hydroelectric segment (16% of total electricity generation) are exposed to pricing volatilities when selling electricity at market spot prices. In H1 2012, the weighted-average HOEP was 2¢ per kilowatt hour (kWh), compared to the price of 3.2¢/kWh in H1 2011, as natural gas prices declined during the period. In addition, electricity generation by the unregulated hydroelectric segment declined in H1 2012 to 6.9 terawatt hours (TWh), compared to 8.1 TWh in H1 2011, as water levels were below normal. The combination of lower spot prices and lower volume decreased the segment’s spot market sales to $145 million in H1 2012 from $259 million in H1 2011 (44% decline), leading to the Company’s reduced earnings.

OPG’s lower earnings for H1 2012 have led to weakening key credit metrics but are still within its rating range. Going forward, the weak electricity wholesale environment is expected to continue to have a negative impact on OPG’s non-regulated power earnings, specifically for the hydroelectric segment. However, DBRS notes that nearly 80% of the Company’s generation output is still produced from the Company’s stable regulated assets. OPG’s regulated segments continue to provide the Company with strong and stable earnings, representing more than 70% of EBITDA in H1 2012 and averaging approximately 60% for the past five years. The stable earnings from the regulated operations are expected to offset the volatility of the unregulated segments over the medium term.

Although DBRS remains concerned about the continued challenging merchant power market environment and its volatile effects on the Company’s financial profile, the Company still benefits greatly from its regulated operations. In the medium term, volatility could further be offset by more capacity coming from regulated and contracted assets, with two major capital projects (Niagara Tunnel and Lower Mattagami River) coming online in 2013-2015, leading to reduced earnings volatility in the medium term.

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

The applicable methodology is Rating Companies in the North American Energy Utilities (Electric and Natural Gas) Industry (May 2011), which can be found on our website under Methodologies.