RESEARCH
Industry Report Card:
Top Seven Canadian Utilities Reflect Ongoing Sector
Stability
Publication date:
Primary Credit Analyst:
Secondary Credit Analyst:
27-Oct-2006
Nicole Martin, Toronto (1) 416-507-2560;
nicole_martin@standardandpoors.com
Kenton Freitag, CFA, Toronto (1) 416-507-2545;
kenton_freitag@standardandpoors.com
Standard & Poor's Ratings Services' Utilities, Power, and Project Finance group in Toronto is introducing
an interim report card (in the fall and spring) that will include up-to-date commentary on the largest debt
issuers in the Canadian utility sector. This biannual publication includes companies in the Canadian gas
and electricity sector with public debt outstanding of about C$3 billion or more. Standard & Poor's will
continue to publish a report card for the all rated Canadian utilities, also biannually (in the winter and
summer).
Commentary/Key Trends
Credit quality stays stable
The Canadian utility sector continued its trend of stable credit quality, reflecting a focus on the expansion
of lower risk, regulated core assets; modest M&A activity; and nothing on the horizon to suggest further
material market restructuring in any of the provinces. Stable outlooks continue to outnumber negative
outlooks and CreditWatch negative placements by more than three-to-one, similar to third-quarter 2005.
The sector remains solidly investment grade, with all issuers falling within the 'A' and 'BBB' ratings
categories.
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Chart 1
Chart 2
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High capital requirements found across the sector
Standard & Poor's expects high capital requirements to dominate the utility scene in Canada for the
remainder of the decade. New electric- and gas-infrastructure (production and delivery) is required across
the country to renew aging assets and meet increasing demand driven by both domestic organic growth
and increasing oil and gas exports. On the electricity side, multibillion-dollar transmission renewal and
expansion is underway in both Alberta and Ontario. Several major new hydroelectric generation facilities
are under construction, and more are expected. In addition, two major nuclear rehabilitation projects are
proceeding in Ontario and New Brunswick, and more are likely. Supplementing these large
capital-intensive projects, are other new generation projects, both large and small, being built by
independent power producers. For instance, we expect a total of 3,600 MW of new generation capacity
(predominantly gas-fired) in Ontario alone to be brought in-service in 2007 and 2008. On the oil and gas
delivery infrastructure side, more than C$10 billion in various capital expenditure opportunities for new oil
and gas pipelines in the next several years have been identified. Nevertheless, which projects will actually
proceed is not clear. Many of these projects relate to the burgeoning development in the Alberta oil
sands.
We do not expect related pressure on financial strength to have a large impact on credit quality in the
sector. Canadian utility financial polices tend to be aggressive with leverage, and regulators parsimonious
with returns. As a result, most companies in the sector will not generate sufficient cash flow from
operations to fully fund expected capital expenditure in the period of expansion. The bulk of capital to be
spent, however, will become part of regulated rate base and, once complete, companies are expected to
recoup both their cost of capital and earn a return on equity. Furthermore, debt raised to build new
generation will generally enjoy the support of relatively stable cash flow from long-term contracts with
solid government counterparties. Limited new merchant generation is expected.
Modest M&A activity
M&A activity originating within Canada has been relatively modest in 2006. Both utilities and power
income funds are focused on opportunities south of the Canada-U.S. border, with the equivalent of about
C$1 billion year-to-date in announced acquisitions expected to close in 2006. Fortis Inc. (BBB+/Stable/--)
purchased an equity interest in the utility serving the Turks and Caicos to complement its utility equity
holdings in the Cayman Islands. Brookfield Power Inc. (BBB/Stable/A-2) announced the acquisition of
several hydroelectric facilities in the northeastern U.S. EPCOR Power L.P. (A-/Watch Neg/--) announced
the purchase of U.S.-based Primary Energy Ventures LLC, and Gaz Metro Inc. (A-/Negative/--)
announced the purchase of Green Mountain Power Corp. (BBB/Watch Pos/--), a Vermont-based electric
utility.
Market conditions more favorable for gas-fired generation in Alberta than Ontario
Electricity commodity prices in Ontario have been flat, with limited volatility. Average monthly on-peak
prices have remained below C$55 per megawatt-hour (MWh) since January 2006. This can be attributed
to mild weather (in both the winter and summer months) and improved nuclear performance, serving to
limit dispatch opportunities for gas-fired generation. These pricing patterns are a departure from higher
and more volatile prices in 2005. The credit impact has not been significant to date, as there is limited
gas-fired merchant generation in the province.
Alberta's electricity market has not enjoyed the same period of calm. Monthly average on-peak prices
have moved between C$51 per MWh and C$168 per MWh since January 2006. Higher price volatility in
second-quarter 2006 relative to first-quarter 2006 was due to lower coal availability and an increase in the
percentage of unplanned outages, both of which led to gas-fired generation being dispatched more often.
Average electricity prices in Alberta were somewhat contained by a seasonal increase in import volumes
from British Columbia, driven by higher water levels in the Pacific Northwest. Hydroelectric output in the
region was up 33% in the first half of 2006 compared with the first half of 2005, leading to more profitable
export opportunities into the coal- and gas-based Alberta market for the British Columbia Hydro & Power
Authority.
Issuer Review
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Table 1
Issuer/Corporate credit rating*/Comment
Analyst
Electric utilities
Canadian Utilities Limited (CU) ( A/Stable/A-1 )
In second-quarter 2006 (ended June 30), CU reported year-over-year growth in earnings due primarily to
higher contributions from its natural gas storage operations and higher contributions from the sale of natural
gas liquids at Atco Midstream. The increased earnings were somewhat offset by an unfavorable tax
reassessment. Credit measures were stable, anchored by the consistent earnings contributions from its
utilities and power generation segments.
Hydro-Québec ( A+¶, A-1+¶ )
The long-term forecast on the company’s financial profile is asset growth and financial stability, despite high
capital expenditures in the next several years that could increase total debt outstanding by up to C$1 billion by
2010. Hydro-Québec has 1,055 MW of new hydroelectric generation assets under construction, which should
come into service from 2006 to 2008. The company’s strategic divestment of its noncore foreign investments
is essentially complete with the US$1.5 billion sale of Transelec S.A. (BBB-/Stable/--) to Brookfield Asset
Management Inc. (A-/Stable/A-2) that closed in third-quarter 2006. FFO interest coverage improved marginally
to 2.6x at year-end 2005, compared with 2.5x in 2004. Second-quarter 2006 (ended June 30) results were
consistent with 2005 results, and our expectations.
Hydro One Inc. ( A/Stable/A-1 )
The ratings were affirmed Sept. 15, 2006, and take into account Hydro One’s revised estimate of its level of
annual capital expenditures. Subject to regulatory approval and project timing, capital spending by Hydro One
will likely increase to between C$800 million and C$1.3 billion a year for several years, from close to C$700
million in 2005. We expect the company to debt finance about 20% of its capital spending. The capital projects
will, however, add to Hydro One’s revenue-generating regulated rate base in the long term. In addition to
financial pressure on the transmission and distribution utility’s balance sheet, the potential for decreased
profitability and weaker cash flow credit metrics as a result of the Ontario Energy Board's still ongoing generic
cost-of-capital review was also considered. A recent reopening of a transfer tax holiday for municipally held
utilities could prompt some partnerships or asset swaps in the Ontario local distribution company sector.
Kenton
Freitag
Nicole Martin
Nicole Martin
Energy merchants/power developers/trading and marketing
Brookfield Power Inc. ( BBB/Stable/A-2 )
Second-quarter 2006 (ended June 30) results were in line with our expectations. The company reported
hydrology conditions that were slightly above average in the quarter. It expects generation volumes will be
consistent with long-term averages for the remainder of the year. Power prices were somewhat lower than
expected, but this was offset by the company's hedging strategy, a stronger Canadian dollar, and other
operational improvements.
TransAlta Corp. ( BBB/Stable/-- )
In the second and third quarters of 2006, TransAlta management continued to focus on optimizing operational
performance, managing merchant exposure in the North American electricity wholesale market, and shoring
up the balance sheet for the company’s expected next growth phase. We continue to expect adjusted FFO
interest coverage of better than 4x and adjusted FFO-to-total debt coverage of more than 20% in 2006, and
similar results in 2007. A decision regarding a potential joint venture with EPCOR Utilities Inc.
(BBB+/Stable/--) to develop a green field coal-fired electricity generation asset in Alberta toward the end of
this decade is expected later this year. Any change in the ratings will largely depend on TransAlta's ability to
continue to strengthen its balance sheet in the remainder of 2006 and 2007, its ability to recontract merchant
capacity at its Centralia plant at favorable market prices in 2008 and beyond, and the extent of any other
material growth commitments during the same period.
Kenton
Freitag
Nicole Martin
Gas pipelines and distribution utilities
Enbridge Inc. ( A-/Stable/-- )
Enbridge's second-quarter 2006 (ended June 30) results were in line with Standard & Poor’s expectations and
continue to highlight the stability of its credit metrics, with FFO interest and debt coverages and leverage
similar to those at year-end 2005. The company has material growth plans: it has identified at least C$8 billion
in organic growth opportunities in the next five years. Accordingly, the ratings are increasingly focused on the
company’s ability to manage the project risk involved with its expansion as well as maintaining a financial
profile that is supportive of the current rating.
TransCanada PipeLines Ltd. ( A-/Negative/-- )
TransCanada’s second-quarter 2006 (ended June 30) results were modestly higher on a year-over-year basis.
But the operating segments demonstrated opposing trends. The pipeline segment showed declining earnings
due to lower allowed return on equity and a diminishing rate base on its Canadian Mainline and Alberta
System pipelines. Improvements in the energy segment traced to higher volumes and improved margins in the
power portfolio, as well as higher capacity and increased storage spreads in its natural gas storage facilities.
Kenton
Freitag
Kenton
Freitag
*Ratings are as of Oct. 27, 2006. ¶Debt guaranteed by Province of Quebec (A+/Stable/A-1+).
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Quarterly Rating Activity
There were no rating actions for the period on the above listed companies.
Selected Articles
Table 2
Selected Articles
Article Title
Publication Date
Credit FAQ: S&P Introduces Reconciliation Tables To Show Analytical Adjustments To Global Utilities'
Financial Statements
Oct. 11, 2006
Industry Report Card: Canadian Oil And Gas Continue Strong Performances Despite Drop In Crude Prices
Sept. 25, 2006
Criteria: S&P Updates U.S. Merchant Power Rating Methodology And Power Price Assumptions
Aug. 24, 2006
Credit FAQ: Terasen Gas Inc. To Remain Investment-Grade
Aug. 10, 2006
Key Rating Factors For Water Companies Around The World
July 17, 2006
Risk Management, Derivatives Use, And The Canadian Financial Reporting Landscape
May 16, 2006
Contact Information
Table 3
Contact Information
Credit analyst
Location
Phone
E-mail
Nicole Martin, Associate Director
Toronto
416-507-2560
nicole_martin@standardandpoors.com
Kenton Freitag, Director
Toronto
416-507-2545
kenton_freitag@standardandpoors.com
Layla Selick, Research Assistant
Toronto
416-507-2589
layla_selick@standardandpoors.com
Comments and ratings reflect available public data as of Oct. 27, 2006.
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