TEXT - S&P revises Ontario Power Generation outlook to negative

Tue Nov 27, 2012 5:36pm EST

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Overview
     -- We are revising our outlook on Ontario Power Generation Inc. (OPG) to 
negative from stable. 
     -- At the same time, we are affirming our ratings, including our 'A-' 
long-term corporate credit rating, on the company.
     -- The outlook revision reflects the revision of our stand-alone credit 
profile on OPG to 'bbb-' from 'bbb'.
     -- The ratings reflect our opinion of the company's strong business risk 
profile and significant financial risk profile.

Rating Action
On Nov. 27, 2012, Standard & Poor's Ratings Services revised its outlook on 
Ontario Power Generation Inc. (OPG) to negative from stable. At the same time, 
Standard & Poor's affirmed its ratings, including its 'A-' long-term corporate 
credit rating, on the company.

The outlook revision reflects the revision of our stand-alone credit profile 
(SACP) to 'bbb-' from 'bbb'. Based on our criteria for government-related 
entities, based on a 'bbb-' standalone credit profile and a "high" probability 
of extraordinary government support, the negative outlook reflects the 
negative outlook on the utility's shareholder, the Province of Ontario 
(AA-/Negative/A-1+). A further lowering of the SACP or a downgrade on the 
province would lead to a negative rating action on OPG. 

Rationale
The SACP revision reflects our view that OPG's credit metrics could weaken in 
the near-to-medium term. The company is continuing with a number of projects 
that require a significant amount of capital expenditure in the next two 
years. In particular we forecast that the Darlington nuclear facility 
refurbishment together with the Lower Mattagami project will require 
approximately C$1 billion in capital expenditures in each of the next two 
years.  This is in addition to the other projects that OPG is working on along 
with sustaining capital expenditure.

We view this capital expenditure in a regulatory context, which provides 
limited cash flow relief during construction for multiyear projects and a 
balanced-but measured-perspective on yearly rate applications. Accordingly, 
the timing difference between the regulatory asset's development (with the 
consequential debt) and the start of cash flow in the regulatory environment 
(which has allowed moderate rate increases) could stress financial metrics.

The ratings on OPG, which Ontario owns, reflect Standard & Poor's opinion of 
the regulatory oversight of the utility's baseload nuclear and hydroelectric 
assets; a diverse generation portfolio; and dominant market position in 
Ontario. Weak cash flow metrics and exposure to regulatory delay and cost 
overruns related to new construction and refurbishment of existing facilities 
offset the company's credit strengths, in our view. Exposure to merchant 
electricity prices and volume related to OPG's unregulated business further 
constrain the SACP. We rate management as "fair" under our management and 
governance criteria. The company borrows about 80% of its C$4.9 billion 
reported consolidated debt as of Sept. 30, 2012, from the government 
shareholder, through Ontario Electricity Financial Corp. (OEFC).

We base the 'A-' rating on OPG's SACP, which we assess at 'bbb-', and our 
opinion that the ratings on OPG and Ontario are linked. We assess that there 
is a "high" likelihood that the government shareholder would provide timely 
and sufficient extraordinary support in the event of financial distress. This 
reflects our views that OPG's role is "important" to Ontario, that the utility 
plays a major role in the government's energy policy; and that the link 
between the utility and the province is "very strong", reflecting ownership 
relationship, ongoing financial support from OEFC, and the province's strong 
influence in the company's investment decisions. 

In our view, OPG's business risk profile benefits from having about 77% of its 
EBITDA in 2011 supported by regulated sources. These sources include nuclear 
and baseload hydroelectric assets that the Ontario Energy Board (OEB) 
regulates as well as regulated nuclear waste management. Assurance of cost 
recovery and a predictable, albeit moderate, return for these assets is a 
positive credit factor. Historically, although the OEB decisions have led to 
more moderate returns for OPG, given the discretion that the company has with 
respect to its capital expenditure and the resultant level of debt it was able 
to mitigate the impact of lower revenues. However, the company has reached an 
inflection point in its capital plans where significant expenditures for such 
things as the Darlington facility refurbishment and the Lower Mattagami 
project are required. We believe that these projects will put significant 
strain on credit metrics for the next two years.  

The fuel diversity and large number of generating units in OPG's generation 
portfolio mitigate the risk of operational disruptions and enhance its 
business position, in our opinion. As of Sept. 30, 2012, the portfolio of 
assets that the company owns and operates includes: 
     -- 6,606 megawatts (MW) of baseload regulated nuclear generation;
     -- 6,996 MW of predominantly run-of-the-river hydroelectric generation, 
of which 3,312 MW is regulated; and
     -- 5,447 MW of intermediate unregulated thermal generation (projected to 
shut down by 2014).

We believe OPG has a strong competitive position. The company dominates the 
Ontario electricity market, producing 85 terawatt-hours (TWh; most of it 
baseload) of the 142 TWh of electricity consumption in the province in 2011. 
Its unregulated hydro assets typically enjoy a competitive advantage compared 
with higher marginal cost gas-fired alternatives.

Constraining OPG's unregulated cash flows, in our view, are the company's 
exposure to the wholesale electricity price and volume risk due to 
fluctuations in Ontario demand, the inherent uncertainty of available water 
flows, and competitively priced imports from neighboring markets. Wholesale 
electricity prices have struggled in 2012, with the weighted average Hourly 
Ontario Electricity Price at C$24 per MW-hour (MWh) for the nine months ended 
Sept. 30, 2012, compared with the C$32 per MWh in 2011.   

Technical challenges associated with key components of nuclear facilities have 
the potential to expose the units to lengthy outages, hurting cash flow 
performance and increasing capital demands. OPG's nuclear liability 
risk-sharing agreement with Ontario limits the company's used nuclear fuel 
liabilities and partially mitigates the operating challenges. 

In implementing its energy policy favoring renewable energy generation to 
replace the less eco-friendly coal-fired generation facilities, the province 
has directed OPG toward investments in projects on various occasions. It also 
required the utility to shut down the remaining coal-fired plants by 2014. 
Along with these directives, the government has provided ongoing support to 
OPG through loans from OEFC and long-term power purchase agreements with the 
Ontario Power Authority to support the company's other projects. It also 
provides OPG with a contingency support agreement to cover operating costs and 
a modest return on investments of the coal-fired facilities until complete 
closure in 2014. We regard these ongoing supports as important mitigating 
factors to the company's business risk profile. 

We believe OPG's stand-alone financial risk profile is significant. We believe 
stand-alone cash flow metrics are generally weak, partially as a result of the 
material postretirement benefit adjustments and modest return on investments. 
Adjusted funds from operations (AFFO) interest coverage was 2.7x and 
FFO-to-total debt was 9.1% for the 12 months ended Sept. 30, 2012. AFFO, in 
our definition, deducts the contribution to nuclear waste and decommissioning 
funds, which we regard as a cost of ongoing operations. We expect any 
improving trend that might emerge in the next three years to be gradual. We 
forecast that AFFO for the next two years will be approximately C$800 million 
in each of the next two years. Based on the significant capital expenditure 
required, we believe that AFFO-to-debt could fall below 9% in each of the next 
two years.

Liquidity
OPG's liquidity is adequate under our criteria, and should be sufficient to 
cover cash uses in the next 12 months. Standard & Poor's bases its liquidity 
assessment on the following factors and assumptions:
     -- We expect that the company's liquidity sources of about C$2.9 billion 
in the next 12-18 months will exceed its uses by about 1.6x. 
     -- Available cash resources include our expectation of annual cash flow 
from operations of about C$900 million, and available credit facilities of 
C$1.9 billion as of Sept. 30, 2012. The committed and available credit 
facilities comprise a C$1 billion maturing May 2017, a C$700 million bank 
credit facility to support initial construction of the Lower Mattagami 
project, and a C$700 million OEFC facility for Lower Mattagami.
     -- Projected uses of cash in the next 12 months include a sizable capital 
expenditure of about C$1.7 billion. 

We expect that the utility will not pay out dividends in the foreseeable 
future and future debt maturities do not present a material concern, given the 
shareholder's practice of refinancing notes payable at their due dates.

Outlook 
The negative outlook reflects our view of the 'bbb-' SACP, the high likelihood 
of provincial support, and the negative outlook on the province. Although we 
recognize that OPG's cash flow adequacy will be weaker in the next two years 
due to substantial capital expenditure on regulated and contracted projects, 
we believe that the SACP could be lowered if we expect OPG's adjusted 
FFO-to-total debt to stay below 8%-10% or adjusted FFO interest coverage 
weakens to below 3.0x. This could result from unfavorable rate decisions, 
operational issues resulting in unexpected outages in its generation 
facilities, or a move toward a more aggressive financial policy (including 
extended significant debt financed capital expenditure). A decline in the SACP 
to 'bb+' would result in a downgrade on OPG.

For the SACP to move a notch higher, we believe OPG would need to improve 
significantly the level and stability of is overall cash flow strength 
comfortably above 10%-12%. This could result  from an equity injection from 
the province which we consider to be highly unlikely. It could also result 
from some form of additional regulatory cash flow support during the upcoming 
period of high capital spending on large projects that we have seen for other 
Canadian utilities in a similar position. 

We link the ratings on the utility and those on the province through our 
enhanced government-related entity methodology. All else being equal, a 
one-notch downgrade to Ontario would result in a one-notch downgrade in OPG. 
An outlook revision to stable on the province could result in a similar 
outlook revision on OPG. A change in the relationship with the government 
shareholder, which includes changes in ownership, could move the ratings in 
either direction.

Related Criteria And Research
     -- Methodology: Management and Governance Credit Factors for Corporate 
Entities and Insurers, Nov. 13, 2012
     -- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 
2012
     -- Methodology And Assumptions: Liquidity Descriptors For Global 
Corporate Issuers, Sept. 28, 2011
     -- Rating Government-Related Entities: Methodology And Assumptions, Dec. 
9, 2010
     -- Key Credit Factors: Business And Financial Risks In The Investor-Owned 
Utilities Industry, Nov. 26, 2008
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
     -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008

Ratings List
Ontario Power Generation Inc.

                                    To                 From
Outlook Revised To Negative
 Corporate credit rating            A-/Negative/--     A-/Stable/--

Ratings Affirmed
 Commercial paper
  Canada scale                      A-1(Low)
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