DBRS Publishes Commentary on Alberta's New Electricity and Gas Distribution Regulatory Framework

DBRS has today released a commentary on the announced final form of Alberta Utilities Commission's (AUC) Performance-Based Regulation (PBR) and its implications for DBRS-rated issuers.

On September 12, 2012, the AUC released its decision on the five-year PBR framework for distribution utilities in Alberta, expected to commence on January 1, 2013. The purpose of the PBR decision is to reduce regulatory burden and create incentives for distribution utilities to improve operational efficiencies. The structure of the PBR decision is similar to the regulatory framework that has been utilized by ENMAX Corporation (rated A (low)), with the exception of the capital tracker, which was not previously included. DBRS notes that the uncertainty regarding the capital trackers and, to a lesser extent, the initial going-in rate could increase regulatory risk and have a negative impact on ratings for Alberta's distribution utilities. An unfavourable capital trackers outcome could result in restructuring for companies - including layoffs, as evidenced by Toronto Hydro (rated A (high)) - to achieve the deemed return on equity (ROE) of 8.75%. The other factors are viewed as reasonable, and are not likely to have a material impact on utilities' financial profile.

Prior to the PBR framework, distribution utilities in Alberta operated under a Cost of Service (COS) framework. COS allows utilities to recover prudently incurred operating costs and approved capex. DBRS views COS as lower risk relative to PBR, due to uncertainties related to the timing of the recovery of capex under PBR. DBRS remains concerned about the uncertainty regarding the capital tracker and the initial going-in rate, which could increase regulatory risk and have a negative impact on ratings for Alberta's distribution utilities. In addition, utilities will likely experience greater cost-cutting pressure to meet or exceed the PBR's productivity factor; as a result, some utilities may have to undergo restructuring to reduce their operating cost base, including layoffs. DBRS notes that utilities can keep earnings above the allowed ROE during the PBR period, providing an incentive for efficiency improvement. For the Alberta market specifically, where growth in demand is expected to continue, utilities can benefit from the increase in revenue as long as incremental costs are not significant. If actual ROE is greater or less than 300 bps for two consecutive years or 500 bps for any single year, relative to the approved ROE, utilities can file to re-open and review the PBR application, providing downside protection.

Notes:
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.