DBRS Confirms Ontario Power Generation at A (low), R-1 (low), Stable

DBRS has today confirmed the Unsecured Debt and Commercial Paper ratings of Ontario Power Generation Inc. (OPG or the Company) at A (low) and R-1 (low), respectively, with Stable trends. The rating confirmations reflect (1) the relatively stable earnings contribution from OPG’s regulated electricity generation businesses, (2) a reasonable regulatory environment and (3) good financial flexibility.

OPG’s earnings declined significantly for the six months ended June 30, 2012 (H1 2012) due to lower earnings from its unregulated hydroelectric operations. This non-regulated segment was negatively affected by a lower electricity wholesale price in Ontario and a decrease in generation output. Although DBRS remains concerned about the continued challenging merchant power market environment and its volatile effects on the Company’s financial profile, OPG benefits from its regulated operations, which accounted for approximately 80% of total generation output in H1 2012. In the medium term, volatility could be further offset by more capacity coming from regulated and contracted assets, with two major expansion projects (Niagara Tunnel and Lower Mattagami River) coming online in 2013-2015 (see DBRS’s commentary dated August 27, 2012).

OPG also generated a cash flow deficit of approximately $347 million in H1 2012, which was largely driven by higher capital expenditure (capex) requirements to fund hydroelectric and refurbishment projects. As the Company adds new generation capacity to support growth and replace coal-fired capacity, capex is expected to rise significantly. As a result, leverage is expected to rise to around 45% over the next three years. Despite the expected increase in leverage, DBRS views OPG’s leverage as reasonable, as 80% of its long-term debt is held by the Ontario Electricity Finance Corporation (OEFC; rated AA (low)), an agency of the Province of Ontario (rated AA (low)). The remaining 20% is non-recourse project finance debt issued by Lower Mattagami Energy Limited Partnership (rated A (high)) and UMH Energy Partnership. However, any significant increase in external debt not held by OEFC (excluding non-recourse debt) could cause OPG’s credit risk profile to deteriorate to a level that is no longer commensurate with the current A (low) rating.

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.