DBRS Comments on Impact of the Generic Cost of Capital Decision on Alberta Utilities

DBRS Limited (DBRS) today notes that on October 7, 2016, the Alberta Utilities Commission (AUC) released its decision on the 2016 and 2017 Generic Cost of Capital (GCOC) for Alberta-based rate-regulated transmission and distribution utilities (the Alberta Utilities). Based on its review, DBRS views the decision as mostly credit neutral for the Alberta Utilities.

(1) The decision saw the allowed return on equity (ROE) remain at 8.3% for 2016, with a 20 basis point (bps) increase to 8.5% for 2017. As DBRS had previously noted, the Alberta Utilities’ 2013 to 2015 allowed ROE of 8.3% was the lowest among North American utilities (excluding crown corporations), which has placed pressure on some of their profitability measures and credit metrics. DBRS sees the slight increase for 2017 as a modest improvement in the regulatory regime in Alberta, as the ROE will be more in line with the Alberta Utilities’ peers across Canada.

(2) Deemed equity was set at 37% for all but one of the Alberta Utilities. While this represents a 100 bps increase for the transmission utilities, it was a 100 to 300 bps decrease for their distribution counterparts. While DBRS views the slight increase in the deemed equity for the transmission utilities as modestly positive, DBRS notes that under its Rating Companies in the Regulated Electric, Natural Gas and Water Utilities Industry methodology, deemed equity of 37% continues to place the Alberta Utilities in the Below Average category. Additionally, some of the distribution utilities will also see their deemed equity score fall from Satisfactory to Below Average. However, as the distribution utilities are currently operating under a Performance-Based Regulation Plan through 2017, only incremental capital expenditures to be recovered through the capital tracker mechanism will be affected by the new parameters.

Overall, DBRS expects the GCOC decision to, on average, have a neutral effect on the Alberta Utilities. DBRS expects the decrease in the deemed equity for the Alberta Utilities’ distribution segments to be largely offset by the higher allowed ROE and the increase in the deemed equity for their transmission segments. For the transmission utilities, as noted in the DBRS commentary “Impact of Upcoming Generic Cost of Capital Decision on Alberta Utilities” dated September 6, 2016, a 100 bps uptick in the allowed ROE would increase the cash flow-to-debt and EBIT-interest coverage ratios for a generic utility by, respectively, 60 bps and 0.15 times (x). A 200 bps increase in equity thickness would similarly increase the ratios by, respectively, 60 bps and 0.15x.

DBRS continues to consider the regulation in Alberta to be reasonable for the Alberta Utilities’ current ratings due to the high level of cost certainty and downside protection under the current framework. DBRS also considers the AUC’s continued support for the Alberta Utilities to maintain ratings in the “A” rating range as a positive for the regulatory regime. This was evidenced by the particular attention paid in the GCOC decision on awarding an allowed ROE and deemed equity that would result in credit metrics consistent with the “A” rating range.

The following are the major Alberta-based utilities rated by DBRS:

-- Altalink, L.P. (rated “A”)
-- CU Inc. (rated A (high))
-- ENMAX Corporation (rated A (low))
-- EPCOR Utilities Inc. (rated A (low))
-- FortisAlberta Inc. (rated A (low))

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

The applicable methodology is Rating Companies in the Regulated Electric, Natural Gas and Water Utilities Industry (October 2015), which can be found on our website under Methodologies.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.