DBRS Publishes Commentary on Potential Changes to Ontario Electricity Distribution Regulatory Framework

DBRS has today released a commentary on potential changes to the Ontario Electricity Distribution Regulatory Framework and its implications for DBRS-rated issuers. Should the renewed framework increase regulatory risk (e.g., aggressive efficiency targets, uncertainty on capital cost recovery), it could have a negative impact on ratings for Ontario distribution utilities.

The Ontario Energy Board (OEB) is currently assessing a renewed regulatory framework for Ontario’s electricity distribution companies and is expected to release a detailed report outlining this framework in the near future. As each local distribution company (LDC) in Ontario operates in different franchises with varying capital needs, the renewed framework is expected to provide LDCs with more flexibility and options in meeting their needs while maintaining rate stability for consumers. According to the OEB, LDCs will be provided with three alternative regulatory frameworks, including: (1) the fourth generation of the current Incentive Regulatory Mechanism (IRM) framework for LDCs with some incremental capital needs, (2) a custom IRM for LDCs with significant capital needs and (3) an annual indexed framework for LDCs with only sustaining capital needs. Further details will be provided in the OEB’s upcoming report.

The regulatory framework in Ontario has evolved over the years from a Cost of Service (COS) framework to the current IRM framework. DBRS views COS as lower risk, relative to IRM. Under IRM, LDCs are subject to a formula price cap that allows for an annual increase in distribution rates based on inflation less a productivity factor. LDCs are also allowed to file a COS application in the rebasing year, which is generally expected every four years (three years of IRM in-between), and an Incremental Capital Module (ICM) for significant, non-discretionary and prudent incremental capital needs during the IRM period. However, DBRS notes that it is often challenging for LDCs with high capital investment to qualify for ICM and obtain approval for all their capital investment needs. Overall, DBRS views the current regulatory framework in Ontario as supportive.

The commentary features a chart that reflects how the regulatory environment for Ontario LDCs is currently assessed based on DBRS’s criteria guideline (see DBRS study “Assessing Regulatory Risk in the Utilities Sector,” dated May 25, 2012). Upon further review of the OEB’s proposed renewed regulation framework, DBRS will reassess the Ontario distribution regulatory framework and further analysis will be provided. Should the renewed framework increase regulatory risk (e.g., aggressive efficiency targets, uncertainty on capital cost recovery), it could have a negative impact on ratings for Ontario distribution utilities.

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, which can be found on our website under Methodologies.