DBRS Confirms Union Gas Limited at “A”, Stable Trends

DBRS has today confirmed the Issuer Rating of Union Gas Limited (Union or the Company) at “A”, along with its Unsecured Debentures/Medium-Term Note Debentures rating at “A”, its Commercial Paper rating at R-1 (low), and its Cumulative Redeemable Preferred Shares rating at Pfd-2. The trend on all ratings is Stable. The rating confirmations reflect the relative stability of earnings 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.

In the Ontario Energy Board’s (OEB) Decision for Union’s 2013 cost-of-service (COS) application, the OEB approved a return on equity (ROE) of 8.93% (8.54% in 2012) and equity thickness of 36%. Rates are expected to increase in 2013 and have an impact of around 0% to 6% on the average annual total bill, depending on customer location and class. In addition, the OEB found that revenues associated with the optimization of upstream transportation contracts, effective in 2013, are to be considered a reduction of natural gas supply costs, 90% of which are to be credited to customers. As a result, 2012 earnings decreased due to this treatment and around $34 million will be refunded to customers. The OEB also had similar findings in November 2012 for 2011 upstream transportation optimization revenues (refund of $5 million). Union has appealed the November 2012 decision with the Ontario Divisional Court and a hearing and decision is expected by the end of 2013. The decisions had no rating implications as the regulatory framework remained reasonable.

Union’s financial performance continued to benefit from the ongoing expansion of higher-margin non-regulated natural gas storage facilities. However, DBRS is concerned about its rising exposure to the non-regulated business, which affects Union’s overall business risk profile and increases potential earnings volatility. Non-regulated earnings increased to approximately 15% in 2012 (DBRS estimate) from 10% in 2008 and are expected to continue to rise over the medium term. The Company is expected to continue to generate free cash flow deficits over the medium term as a result of expansions and upgrades. DBRS expects the Company to finance free cash flow deficits through managing dividends and issuing debt in a prudent manner that will maintain its debt-to-capital ratio within DBRS’s “A” rating range.

Notes:
All figures are in Canadian unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodology is Rating North American Energy Utilities (Electric and Natural Gas) Industry, which can be found on our website under Methodologies.