DBRS Publishes Commentary on the Ontario Energy Board’s Report on the Renewed Regulation Framework for Electricity Distributors

DBRS has today released a commentary on a report published on October 18, 2012, by the Ontario Energy Board (OEB) on the renewed regulatory framework for electricity distributors. As discussed in the DBRS press release dated October 3, 2012, the report outlines three rate-setting options available for Ontario’s local distribution companies (LDCs): (1) the 4th Generation Incentive Regulation (IR) for LDCs with some incremental capital expenditures (capex) above and beyond the historical average, (2) a Custom IR for LDCs that have significant capital requirements and (3) an Annual IR Index for LDCs with relatively low and stable operating and capex budgets. The majority of DBRS-rated issuers will likely choose either the 4th Generation IR or the Custom IR due to the rising capex needed to maintain their aging infrastructure and to retain operating efficiency for a longer time period. No real credit substance was disclosed in the document. Details on key factors in the IR framework that could affect the credit quality of LDCs are expected to be disclosed in mid-2013.

DBRS will assess the key credit drivers when additional details are provided by the OEB in mid-2013. 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 LDCs. If LDCs are to operate under a 4th Generation IR framework for a longer period, they will increasingly face uncertainties related to unforeseen costs regarding changes in regulatory requirements and higher-than-expected operating expenses (e.g., higher-than-expected labour costs). The longer the IR period, the greater the risk LDCs will face. However, if actual return on equity is greater or less than 300 basis points (same range as the 3rd Generation IR) or if performance erodes to unacceptable levels, LDCs or the OEB can initiate a regulatory review of the IR application, providing downside protection.

The following are three key meaningful disclosures from the report: (1) the three rate-setting options will not be available for LDCs until May 1, 2014; (2) to assist the OEB with its implementation planning, stakeholder working groups will be established to evaluate the implementation tasks and outstanding details; and (3) details on the IR mechanism pertaining to performance measurements, benchmarking and inflation and productivity and stretch factors are expected to be provided by June/July 2013.

An overview of the three rate-setting options is provided in the commentary.

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.

A copy of this commentary is available by contacting us at info@dbrs.com.