DBRS Updates Rating Report on Union Gas Limited

DBRS has today updated its report on Union Gas Limited (Union or the Company). The credit quality of the Company reflects the relatively stable earnings contributions from Union’s regulated businesses (i.e., gas distributions, regulated storage and gas transmission), which accounted for the majority of consolidated earnings, and Union’s reasonable credit profile.

Union’s financial performance continued to benefit from the ongoing expansion of higher-margin non-regulated natural gas storage facilities, offset by higher cost-cutting (as a result of Union’s regulatory regime having changed from a cost-of-service (COS) system to an incentive regulation (IR) framework in 2008). However, DBRS is concerned about rising non-regulated business exposure affecting Union’s overall business risk profile and increasing earnings volatility. Non-regulated earnings increased from 10% in 2008 to approximately 15% to date (DBRS estimate) and are expected to continue to rise over the medium term. DBRS expects Union to maintain its debt level within the approved regulatory level (Union’s debt leverage was 60.8% as at June 30, 2012), given its rising non-regulated business exposure. DBRS notes that the Company has filed a rate case for the 2013 rebasing, asking for a 40% deemed equity (currently 36%) and higher return on equity (ROE) (currently 8.54%). If this request is granted, DBRS expects Union to manage its balance sheet in line with the new regulatory capital structure and maintain greater financial flexibility.

The IR framework creates uncertainty in the regulated business, which did not exist under the COS system. Further, Union is required to continue to identify cost-saving opportunities to overcome the productivity factor of 1.82% to improve its earnings. Cash flow deficits are expected over the medium term, due to higher capital expenditures (capex) for storage expansion and gas transmission projects. DBRS expects the Company to finance the deficits through managing dividends and issuing new debt in a prudent manner to maintain its debt-to-capital within DBRS’s “A” rating range.

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

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